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"The collapse of market
fundamentalism in economies everywhere is putting the Chicago
School theology on trial. Its big lie has been exposed by facts
on two levels. The Chicago Boys' claim that helping the rich
will also help the poor is not only exposed as not true, it
turns out that market fundamentalism hurts not only the poor and
the powerless; it hurts everyone, rich and poor, albeit in
different ways... The fruits of Friedman test are in - and they
are all rotten."
Henry Liu |
An economist and his guide, while hunting in Africa, fall
into an elephant trap: twenty feet deep with vertical walls.
“That does it,” says the guide, “we’re done for. No escape, no food, no
chance of being found in time.”
“Nonsense,” said the economist, “I can get us out of here.”
“And how do you propose to do that?,” the guide asks.
The economist replies: “Well, first we posit a ladder.”
Economists are no more inclined than the rest of us to live in a fantasy
world – not, that is, as they go about the practical business of living
their everyday lives. But when economists write technical papers and teach
university courses, they often enter a theoretical realm of abstract
concepts such as “economic man” (homo economicus) and “perfect
markets,” articulated with virtuoso advanced mathematical manipulations.
Very elegant, and very unreal.
Many economists, perhaps most, appreciate the limitations of economic theory
in explaining and predicting social behavior and political trends. Some
economists, however, claim to find in traditional (i.e. “neo-classical”)
economic theory, the key to articulating and proposing public policy. It’s
called “market fundamentalism,” and it has dominated American politics since the
Reagan administration. It has also led this nation to the brink of economic
disaster.
Market fundamentalism has led us to this crisis because its proponents in
academia, politics and the media have been bewitched by theoretical concepts
that apply imperfectly, if at all, to the real world in which we live and
work. In particular: they posit an imaginary creature (“economic man”) that
inhabits a mythical environment (the “perfect market.”)
Economic Man (Homo Economicus).
In neo-classical economic theory,
“economic man” is a hypothetical individual who is a complete egoist,
motivated solely by the self-interested desire to maximize his “preference
satisfaction.” Homo Econ’s motivation is manifested by his
willingness to pay for these satisfactions in a “free market.” Neo-classical
theory also postulates that “all goods that matter to individuals ... must
be capable of being bought and sold in markets” and “anything that is valued
instrumentally ... can be handled by economics, be it acts of friendship or
love.” (Freeman and Edwards. For citation of sources,
follow this link).
“Economic man’s” behavior is described, in neo-classical jargon, as
“rational.” By implication, the self-sacrificing behavior of saints and
heroes is “irrational.”
Clearly, “economic man” exists nowhere outside of Ayn Rand’s novels and,
perchance, on Wall Street. And this is fortunate, for we wouldn’t want him
for a neighbor.
In fact, there is much more to a fulfilled and moral life than
self-interested “preference satisfaction.” Such a life also includes values
that can not be priced in a free market. Among them:
-
Truth.
Scientists and scholars offer evidence and sound arguments, not bids. In
courts of law, purchased verdicts are not only invalid, they are crimes.
-
Civic Values
such as justice, due process, civil rights, and the franchise, are not
for sale. The governing impulse of economic man (qua consumer) is “I
want.” The governing impulse of the citizen is “we need.”
-
Distributive Justice.
The economic concepts of “efficiency” and “utility maximization” do not
touch upon the moral issue of the just distribution of wealth. “Just
compensation” and "fair distribution" are moral, not an economic,
concepts. A slave economy can, in classical economic theory, be
perfectly “efficient” (i.e., "Pareto Optimal").
-
Love, friendship and loyalty
which is bought is less valuable than that which is given freely. As
philosopher Mark Sagoff reminds us, “a civilized person might climb the
highest mountain, swim this deepest river, or cross the hottest desert
for love, sweet love. He might do anything, indeed, except be willing to
pay for it.”
-
Moral values,
which refer to
the
worth of persons, are systematically excluded from neo-classical
economic theory.
A public policy for “economic man,”
systematically detached from criteria of truth, civic value, distributive
justice, friendship and loyalty, is a policy that any civilized person
should reject, and reject on non-economic grounds. (See my
“Why
Economics Fails as a Sole Foundation of Public Policy,” for an
elaboration of these points and a citation of sources).
The Perfect Market.
Neo-classical economists, and their
political acolytes, are convinced that “free markets,” completely
undisturbed by government interference, yield optimum social and economic
results. For example:
“In the free market, the individual
would have to produce a good that the other person desired in order to
receive a good in return. Adam Smith's "invisible hand" of the market
guides all participants in society to promote the best wishes of
everyone else by pursuing his own wants and desires.” (Jacob Halbrooks)
“[T]he free market allows more people to satisfy more of their desires,
and ultimately to enjoy a higher standard of living than any other
social system... We need simply to remember to let the market process
work in its apparent magic and not let the government clumsily intervene
in it so deeply that it grinds to a halt." (David Boaz,
Libertarianism, a Primer, p. 40, 185.)
"A free market [co-ordinates] the activity of millions of people, each
seeking his own interest, in such a way as to make everyone better
off... Economic order can emerge as the unintended consequence of the
actions of many people, each seeking his own interest." (Milton and Rose
Friedman: Free to Choose, pp 13-14).
History has taught us, time and again,
that such assertions are true only in the purely abstract world of
neo-classical economic theory. They are not true in the real world that we
inhabit. To understand why this is so, we need only list the conditions of
“the perfect market” postulated by economic theory.
-
All participants are “perfectly
rational” egoists – i.e., are “economic men.”
-
There are many participants in the
market.
-
All participants have access to all
relevant knowledge.
-
There are no transaction costs.
-
All transactions are mutually
beneficial.
-
There are no externalities (i.e.,
consequences to non-participating “third parties”).
Clearly, there are no “perfect markets”
anywhere on earth, apart from the imaginations of economists. For consider:
(a) “Economic man” is a myth, or at the
very least extremely rare. As noted above, most individuals engage in
economic transactions for several reasons, some of them non-economic.
(b) Participation in markets is restricted to those with the ability to pay.
Public policy decisions, on the other hand, should involve the rights and
welfare of many who are systematically excluded from market activity;
namely, the very young, the very poor, animals, and future generations.
Furthermore, unregulated markets are self-eliminating, because capitalists
detest competition and strive constantly to eliminate it. The remedy? The
enforcement of anti-trust laws and regulation, which means, of course,
“interference” by governments in the marketplace.
(c) The multi-billion dollar advertising and public relations industries are
devoted to the task of persuading rather than informing. And
persuasion involves the withholding of relevant information (e.g. health
risks) and the dispensing of distorted and false information. Caveat
Emptor!
(d) All transactions in the real world exact costs. Among them are the costs
of enforcing the laws required for markets to take place at all (e.g. fair
disclosure, patents and copyrights, contracts, civil and criminal courts,
etc.), and this of course means government, which is so despised by “free
marketeers.”
(e) Transactions are frequently not mutually beneficial, due to fraud (i.e.,
violation of “relevant knowledge condition”), the remedy of which is civil
suits, which requires the “transaction costs” of the enforcement of law and
the appeal to courts.
(f) External costs of market transactions are more the rule than the
exception. Innocent, non-consenting parties are routinely impacted by
economic activity. Among these external costs are environmental pollution,
urban decay, public health costs, etc. Third-party “stakeholders” have no
say in economic transactions. Their only recourse for protection and
compensation is to the sole agency legitimately established to represent all
citizens: the government. (See my
“Market
Failure: The Back of the Invisible Hand).
Summing up: “Economic man” and “perfect markets” are abstract constructs
which, due to their clarity and simplicity, allow theoretical economists to
devise complex mathematical models. However, they have no counterparts in
the real world, which compromises the application of these concepts in
public policy.
Case-In Point: Milton Friedman on Free Trade.
Foreign trade and currency exchange rates
provide a vivid example of the rule, “The theory is beautiful, but reality
is baffling.”
According to free market theory, foreign exchange rates should be
self-regulating, negative feedback functions, like house thermostats. The
heat rises, the furnace shuts off, the heat drops, the furnace kicks in,
perpetuo moto.
Similarly with foreign trade. If there is a “trade imbalance,” say between
Japan and the United States, as dollars go to Japan and consumer goods are
imported to the U.S., the Japanese will acquire a surplus of dollars causing
the value of the dollar to fall with respect to the yen. U.S. consumer goods
will then be less expensive than Japanese products, thus encouraging a flow
of the yen to the U.S. to purchase American goods. Then the value of the
dollar will rise until foreign goods once again become competitive. And so
on, back and forth, like a thermostat. It’s all perfectly automatic – a
“spontaneous order,” as the libertarians call it – no governmental
interference (e.g. tariffs) required.
This is how Milton Friedman describes it:
If foreign exchange rates are
determined in a free market, they will settle at whatever level will
clear the market. The resulting price of the dollar in terms of the yen,
say, may temporarily fall below the level justified by the cost in
dollars and yen respectively of American and Japanese goods. If so, it
will give persons who recognize that situation an incentive to buy
dollars and hold them for a while in order to make a profit when the
price goes up. By lowering the price in yen on American exports to
Japanese, it will stimulate American exports; by raising the price in
dollars of Japanese goods, it will discourage imports from Japan. These
developments will increase the demand for dollars and so correct the
initially low price. (Milton and Rose Friedman, Free to Choose,
p. 47).
In theory, it’s all very neat and so
simple: “all things being equal.” But in the real world, “all things” are
never equal. Instead, the ecologist’s rule applies: “you can’t do just one
thing.”
What if that flow of dollars abroad is accompanied by a dismantling of the
U.S. industrial base? Then, when the time arrives for U.S. manufacturing
goods to be competitive with foreign goods (due to the weakening of the
dollar), there will be no more American-made goods on the market. Moreover,
with the outsourcing of U.S. jobs overseas and the decline of median
disposable income, fewer American can afford to buy foreign consumer goods.
Regressive tax rates cause the nation’s wealth to flow to the very rich, who
send their investments abroad in outsourced industries. A shrinking tax base
results in a disintegrating physical infrastructure and a decline in higher
education, followed by fewer scientists and engineers, and less basic
research and development. Thus today the United States excels only in
military technology, as it needlessly spends more on the military than all
the rest of the world combined, building 3.5 billion dollar aircraft
carriers to fight an “enemy” without an air force, and billion dollar
submarines to fight an “enemy” without a navy.
This is what happens when public economic policy is abandoned to “the will
of the free market” – an abstraction with, we are expected to believe, a
benevolent “mind” of its own. This is what happens when a government puts
the fate of the nation’s economy in the hands of wealthy individuals and
corporations; individual agents without social conscience and with nothing
more than their short-term profits in mind. In fact, if corporate
officers dared to act in behalf of "social welfare," they would be violating
their "fiduciary responsibility" to their stockholders and subject to civil
suits. That's the law!
In the face of such grim realities, the neat “negative feedback” model of
Friedman’s free-trade theory is irrelevant. It belongs to the abstract world
of “theory,” not to the real world. In the real world, the thermostat is
broken, the furnace will not turn on: down, down, down, goes the
temperature.
“Physics Envy:” Formal modeling vs. Empirical Investigation.
Neo-classical economists regard themselves
and their discipline as more “formalist” than “empirical.” “Applied
economists” such as John Kenneth Galbraith, Kenneth Boulding and Herman Daly
who study the behavior of markets in “the real world” and attempt to draw
inferences and conclusions from these studies, are regarded as an inferior
caste: they rarely win Nobel Prizes and are conspicuously absent from the
rosters and the publications of right-wing and libertarian think-tanks. (The
remainder of this section is adapted from my
“Beautiful Theory vs. Baffling Reality”).
Economic formalists are ever-ready to offer explanations of the state of the
nation’s economy, and to issue warnings of dire consequences if their
recommendations are not adopted, a willingness that is compounded as the
economist’s academic training is mixed with his political sentiments and
motives.
Consider, for example, an analysis of the prosperity of the Nineties, the
longest sustained economic boom in our history. Who gets the credit? The
Democrat replies, “Why Bill Clinton, of course!” “Not so fast,” says the
Republican economist. “That prosperity was a time-lagged result of the
policies of Bush I, aided by the wise legislation of the Republican Congress
after the GOP took control in 1995.”
And what caused the stock market bust and recession early in the Bush II
administration, and the humungous deficits that followed? Quoth the
Democrat: “Clearly, those tax breaks to the rich failed to ‘trickle down’
and stimulate economic growth as the GOP promised.” “Wrong again,” says the
GOP apologist. “The bust and the recession were “time-lag” effects of
Clinton’s horrible economic policies. As for the stimulus from the tax
breaks, be patient – just you wait.”
I trust that you can see where this is going. “Time lag” – the gift to the
economic theorist that keeps on giving -- is just one of several
“explain-away” devices that economists fall back on, when their policies and
predictions don’t quite turn out right.. Whenever “our” policies fail, or
“their” policies succeed, there is always one or another of a myriad of
macroeconomic imponderables to fall back on for an explanation. It’s no
wonder that the disputes that ensue are never definitively resolved.
The problem is not that economic theories explain too little – it's that
they “explain” too much, so that whatever happens, their defenders have an
“explanation,” and likewise, their opponents have a contrary "explanation."
That’s just another way of saying that politically motivated economic
projections and explanations are “non-falsifiable,” and non-falsifiability
is the definitive mark of non-science.
Astronomers can predict within seconds, eclipses hundreds of years into the
future. If economists had a reliable 60% success rate in their
macro-economic predictions, they could all retire at forty on the returns
from their stock market investments. And as we all know, they don’t.
Please understand: I am not "anti-markets." The failed economic experiment
in the Soviet Union proved conclusively that a centralized command economy
is vastly inferior to a market-based system of pricing, distribution,
innovation and quality control. Having "shopped" in both the Soviet Union
and the United States, I know this from personal experience. Furthermore,
because human beings in significant aspects of their lives, do, in fact, act
upon economic motives, a scholarly examination of market behavior has
valuable implications for numerous disciplines, including environmental
studies and political science.
In short, I do not assert that a study of markets and economic theory should
count for nothing. Instead, I protest that they should not count for
everything. Homo economicus is an ingredient of our nature that we
would be well advised to study. But our lives consist of much more than
buying and selling. We also love and we sacrifice, and we have goals and
concerns that transcend our self-interest. And we seek, both personally and
collectively, truth, justice, and personal moral virtue, none of which can
appropriately be bought or sold in markets
With this conviction, I am joined by many esteemed economists, among whom
are some of the severest critics of neoclassical economics. These include
Herman Daly, Nicholas Georgescu-Roegen, Kenneth Boulding, Paul Krugman,
James Galbraith and Amartya Sen, all of whom possess a clear view of the
limitations of their discipline. Indeed, my quarrel is less with economists
than with politicians and policy-makers who have skimmed easy formulas and
simplistic generalizations off the top of the neo-classical economic theory,
and put them to work in behalf of their special political and economic
interests.
Even so, the above-listed dissenting economists, whom I admire enormously,
report that there is in fact a dominating "orthodoxy" of neo-classical
thought in the discipline of theoretical economics, and that this orthodoxy
has had enormous influence upon both public policy and politics.
I can validate their report with my own experience. Often, when I have
mentioned the names of these mavericks to economist colleagues, I find that
I have evoked stares of disbelief or even condescension, such as one might
expect from a fundamentalist preacher upon hearing the name of Charles
Darwin. I once asked Herman Daly why he is regarded as an “outsider” by the
mainstream of his profession. He wryly replied that it was probably because
he permits the elegance of formal economic theory to be contaminated by
compelling facts of biology and physics. Meanwhile, the true believers read
with admiration the pronouncements of economists such as Julian Simon, who
confidently assert that the omnipotence of the free-market and the
omniscience of future entrepreneurs can overcome trivial physical
constraints such as the second law of thermodynamics. (See my
“Perilous Optimism”).
I once heard Paul Ehrlich remark to Johnny Carson that if an engineer
proposed to design an aircraft for an exponentially expanding crew, he would
rightly be regarded as mad. Yet when an economist proposes an economic model
that posits perpetually expanding population and resource consumption, he is
regarded as eligible for the Nobel Prize for economics.
Happily, this era of free-market dogmatism may be coming to an end, as the
dreadful consequences of its application are cascading upon us. Some of the
High Priests are, in the face of stark economic realities, abandoning the
cult. Leading the way is
Alan Greenspan, who told Henry Waxman’s Committee, “those of us who have
looked to the self-interest of lending institutions to protect shareholder’s
equity (myself especially) are in a state of shocked disbelief... I made a
mistake in presuming that they were best capable of protecting their own
shareholders.”
The dogma of market fundamentalism may, at long last, be replaced by what
James Galbraith calls “a new spirit of pragmatism, “ which, he writes,
“surely requires that we discard the metaphor of market determinism – whole
and entire. No more, let us bow and scrape before that altar. Markets have
their place – they are a reasonably open and orderly way to assure the
distribution of services and goods. They are not a general formula for the
expression of social will and the working out of social problems.”
Thus might the economic strategy of FDR’s New Deal be reinstated: constancy
in ends – national prosperity and economic justice – and flexibility in
means. “Don’t just sit there, do something! If it works, keep it. If it
fails, try something else.” In economics, as with any viable science, theory
must be tested in the real world, whereupon the theory is either validated,
modified, or discarded.
Looking back through history, we might wonder how it is possible that
intelligent and educated people once accepted uncritically such notions as
astrology, judicial trial-by-combat, the demon-possession theory of disease,
and alchemy. Today, more and more sophisticated observers of society and
politics are wondering how homo economicus, a creature bereft of
sympathy, humanity, and noble aspiration, and "the perfect market," a
"place" devoid of any social contacts more elevated than market
transactions, ever came to be regarded by our political elites as the
foundation of a just political order.
Copyright 2008 by Ernest Partridge
