The first of the two discussions of economics posted on the Mysearch website was entitled ‘The Evolution of Economics’, which represented an initial learning curve covering some of the most fundamental concepts of economics, which then developed to include some wider issues that might yet affect the global economy - see The Growing Storm, The Limits to Growth and The Future of Eco-nomics . However, this second discussion entitled Economics: Fact or Fiction is more of a return to the learning curve covering the management of the economy and whether this management is more about damage limitation in the here-and-now rather than the development of an economic theory that might serve us better in the future. We might summarise this general concern with a question:
Do economists really understand how the economy works?
Clearly, any answer to this question requires some weight of authority rather than just possibly uninformed opinion, such that we might reference economists like Michael Hudson, Steve Keen and Mark Blyth who appear to question their own profession, when they challenge the ability of mainstream economic models to make accurate predictions about the past, let alone the future.
As such, we might use the graph above as a predictive example of GDP growth made by IMF economists since 2010. We might see that their forecasts only aligned to the actual GDP growth in the first year the prediction was made, such that it was hardly a prediction and that the ongoing forecasts over inflate GDP growth by a sizeable margin of error. Clearly, this type of forecast suggests that the IMF economic model was wrong and therefore questions the ability of the IMF economists to recognise the underlying problems. Of course, if you believe that this might have simply been a one off mistake by the IMF, then the following quote by Michael Hudson might give you further food for thought:
The IMF also admitted that its own analysis of the future development of debt was wrong ‘by a large margin’. The IMF had originally projected Greece would lose 5.5% of its economic output between 2009 and 2012. The country has lost 17% in real gross domestic output instead. The plan predicted a 15% unemployment rate in 2012. It was 25%
Again, if you believe this example is not representative of the contribution of economists, then the following quote taken from Steve Keen’s book ‘Debunking Economics’ might be even more alarming:
The position I now favour is that economics is a pre-science, rather like astronomy before Copernicus. I still hold out hope of better behaviour in the future, but given the travesties of logic and anti-empiricism that have been committed in its name, it would be an insult to the other sciences to give economics even a tentative membership of that field.
While this discussion accepts that it does not have the weight of authority to question the detailed arguments of current economic theory, it is not unreasonable for it to quote respected economists who question the accuracy of their own profession. However, while this discussion has questioned the development of economics throughout the 20th century and into the 21 st century, it has also argued that society at large has to also accept its share of the blame for the current state of the world. For the outcome of any economic theory can be thwarted by a myriad of social and political issues that can profoundly affect the stability of any economy in unpredictable ways. In fact, it might be argued that all too often the mechanisms of economic theory have been undermined by human greed and political self-interest. Therefore, the idea that economics could ever accurately predict some future outcome based on only theoretical assumptions about how people, businesses and governments ‘should’ as opposed to ‘actually’ cooperate with each other in order to ‘ideally’ organize production and utilisation of resources may always be limited.
So what might be said by way of commentary of economics?
While there are some who advocate a return to some form of gold standard, it is not exactly clear what form of gold standard could actually be used. For the story of the goldsmith turn banker might suggest that it was the practicality of gold coinage that first led to the use of fiat money. Likewise, in a world dominated by the convenience of digital money, it would seem that the only ‘value’ gold would have within a global monetary system would be to restrict the printing of fiat currencies to the value of gold held in reserves by each nation state. However, the value of fiat money in global circulation now far exceeds the current value in gold by orders of magnitude. If so, the only way this difference might be re-balanced is by an exponential rise in the price of gold, which might then only benefit those already holding gold as an investment. So while some will still argue about the benefits of gold having some form of ‘intrinsic value’, it is unclear what this really means as all forms of money, even gold, only has a value when exchanged for something else, e.g. survival needs.
But can we simply ignore the apparent problems being caused by fiat money?
In isolation, it is not clear that fiat money is any more of a problem than any other form of money, if the main problem associated with money is simply not having enough of it, especially if considered in the context of wealth inequality. In the 20th century, the use of fiat money was essentially decoupled from all earlier gold standards, which then removed many of the obvious restrictions on the amount of fiat currency that could be in circulation. However, it is unclear that governments simply printed more fiat money just because they could, but rather in response to maintain the perception of continuous economic growth. In part, the two world wars of the 20th century had helped fuel an explosion of production and consumption, aided by technology advances, which grew the economies of the developed world and increased the total amount of currency in circulation. However, by the 1980’s, production in the western economies was being diverted towards developing nations for cost reasons, such that consumption started to be maintained by growing debt created by easier access to credit within deregulated financial markets. As outlined in the discussion of cyclic dynamics, growth can be attributed to both productivity and debt, but by the late 1990’s, it would appear that economic growth was increasingly being supported by debt-laden consumerism. This unbalanced form of growth was then compounded by the preference of the financial sector to focus the majority of ‘new money’ being created by private banks into what was perceived to be safe-bet investments, e.g. stock markets and property markets. However, this preference really only helped increase the income of those wealthy enough to own stocks and shares in the first place as share prices continued to rise. On the other hand, the investment into the property market only helped sustain the inflation of house prices, which increased the overall level of private debt underpinning the economy and, of course, the profit made off this debt by the financial sector in interest payments. So, within an unregulated system fuelling more frequent boom and bust cycles, the wealth inequality between the top 10% and bottom 50% continued to grow, which has been reflected in the remuneration of top executives that increased from 20:1 in 1965 to over 350:1 in 2012 in comparison to the average wage.
So is the use of fiat currencies a real problem?
In the context of global economics, it would seem too simplistic to consider fiat money as the root of all problems we now see around us. For there is possibly a far better case against the weak regulation of the various financial institutions that many might argue has allowed greed and self-interest to go both unchecked and unpunished. However, we possibly need to make some clearer distinction between greed and self-interest within the economy at large. As a generalisation, most people may believe that the bailouts and bonuses associated with the financial sector, especially after the 2008 crash, were a reflection of the self-interest, if not the greed, of a small but powerful minority. However, it is unclear whether current economic models are even capable of making such distinctions, especially if this distinction has to be resolved between the effects of greed and self-interest within the wider market economy as opposed to the financial sector in isolation.
Note: We might defined a market economy as one in which decisions regarding investment, production, and distribution are based on supply and demand, which then helps determine the prices of goods and services. However, in such a system, investment can often be heavily influenced by the short-term priorities of financial markets. We might then extend this description to cover free market economies by simply stating that the laws of supply and demand are conceptually free from all government regulation, intervention or price-setting.
Based on the description above, we see that a market economy can be affected by the financial sector as a result of its investment priorities. If so, the wider market economy may be adversely affected by the financial sector acting in its own self-interest rather than the wider interests of the economy. In fact, this concern appears to have played out after the 2008 financial crisis, when government investment in the form of quantitative easing (QE) was often diverted to meet the self-interest, and possibly greed, of some within the financial sector rather than the wider productive economy. At this point, the idea of self-interest is often outlined in terms of a quote from Adam Smith’s in his famous work: The Wealth of Nations:
It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.
However, this quote in isolation ignores the breadth of Smith’s work and the fact that much has changed in terms of a market economy and the breadth of financial institutions since 1776. For as previously argued, Smith was not so naïve as to believe that the self-interest of all individuals could always be reconciled with the collective interest of society, as the two following paraphrased quotes might suggest:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.
The proposal of any new law or regulation comes from men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even oppress the public’.
So while Adam Smith might have supported the idea of a market economy, it is unclear that he would have supported the definition of a totally unregulated free-market, especially given the influence of modern financial institutions. For it would seem that the financial sector has to be constrained to operate within some form of regulatory framework in order to confined the excesses of both self-interest, and possible greed, if social stability and justice are to be maintained.
So what difference is there between self-interest and greed?
Clearly, while some negative connotations can be associated with the idea of self-interest, it does not necessarily imply greed or even unethical behaviour to the detriment of society, as Adam Smith’s ‘invisible hand’ metaphor originally highlighted. However, greed is not just constrained to self-interest, but can extend to the point that all other consequences on society are ignored. Therefore, if the scope of economics includes the study of human actions in respect to the choices and the utilization of resources, then wealth inequality resulting from narrow self-interest, which may ultimately lead to greed, has to be considered within the remit of economics.
But how much of this argument is based on idealism rather than real-world pragmatism?
In the real world, greed is often the accomplice of theft and fraud and, as such, we might recognised that this aspect of human nature is not a new problem. In this context, history tells us that any system of money has always been the focus of theft and fraud, where greed has invariably played a part. However, there is an aspect of the modern world, especially within its financial infrastructure, where the line between self-interest and greed can now be crossed without drawing too much attention, either in terms of moral judgement or criminal punishment.
Note: Today, the fallout from the 2008 financial crisis is still fresh in the memory of most people. However, this was simply the last in a long line of fraudulent financial activity that required a collusion between bankers, regulators, and legislators. For example, the ‘savings and loan crisis’ of the 1980-90’s used a mechanism of financial leverage to purchase bankrupt companies, which formed the basis of a Ponzi-like bubble, which ultimately burst as all bubbles must. However, in the process, deceptive accounting rules were used to hide the true state of the banks involved, while litigation and lobbyists delayed the discovery of the fraud, which only added to the costs that taxpayers had to underwrite.
In time honoured fashion, following each financial scandal or crises that reaches the public’s attention, there is an inquiry that takes years, which purports to identify the major causes and the lessons to be learnt that were not learnt in the previous dozen or so financial scandals. In the case of the savings and loan scandal, a report was published many years after the event in 2005, which attempted to list the contributing factors, which in reality simply concludes that the financial scandal was a collective failure of the system. We might summarise the findings of this report below preceded by a Monty Python quote:
It’s a fair cop, but society is to blame.
1) Fraud matters and poses a risks. 2) It is important to understand fraud mechanisms. 3) Economists grossly underestimate the prevalence of fraud and its impact. 4) Prosecutors have difficulties prosecuting individuals responsible. 5) Politicians who receive campaign contributions from the banking industry can be complicit in obstructing justice. 6) Fraud occurs due to poor regulation. 7) There are conflicts of self-interest. 8) There are not enough investigators in the regulatory agencies to protect against fraud. 9) Regulatory leadership is missing. 10) There is a lack of ethical and social judgement. 11) Stock options can act as a temptation for fraud…...
As indicated, this report was published in 2005, just a few years before the 2008 financial crisis, such that we might seriously question what lessons have ever been learnt. Of course, while every crisis is different in its details, there is an underlying pattern that we might attribute to self-interest bordering on greed and fraudulent theft. So let us also try to summarise some of the details behind the 2008 crisis as another point of reference.
1) In search for ever greater profits, US and other global financial institutions created products based on ever riskier mortgages, while finding ways to sell them as secure investments. 2) Supposedly independent rating agencies ‘appear’ to have endorsed risky mortgage assets with AAA ratings, which were then sold onto global buyers. 3) Many of these agencies subsequently blamed the failure of their ratings on computer automation, possibly suggesting that nobody was personally to blame. 4) Having sold on the risk, the original lenders were no longer concerned as to whether any borrower could actually afford to pay their mortgages. 5) When freed of this risk, lenders used ever more dubious tactics to convince home buyers to take out mortgages without concern of the consequences from which they appeared immune. 6) In a growing credit-driven market, possibly better described as debt laden , the home buyers accepted these mortgage loans without fully understanding that the equity of their homes could fall. 7) When confidence in the house market collapsed, many home buyers lost everything. 8) Faced with the prospect of the economic collapse of its financial institutions, governments stepped in and passed on the cost-losses to its tax payers, thereby creating a debt burden that may take generations to repay. 9) In the midst of this crisis, much of the tax payers’ money effectively ended up in the pockets of the executives of the very financial institutions responsible for the crash in the form of bonuses and gold handshakes.
What most people might realise from these outlines is that the risks to the system associated with self-interest and greed plus fraud and theft is already well recognised. However, as the years pass and we collectively forget the last crisis, lobbyists for the banking and finance industry will try to reassert and reassure politicians, supposedly in control of our legislative laws, that free market capitalism has to be left unregulated, possibly on the basis of the following adage:
Capitalism, like democracy,
may not be perfect, but it beats the alternatives.
And making it as good as possible will advance the future prosperity of us all.
The problem with this type of economic ideology is that that it does not even try to quantify how the system could or should be made better. As such, it seems to disregard what history keeps telling us, i.e. that if those who profit from the financial markets are not regulated in some way, they will continued to exploit the system, some driven by self-interest, others by greed and a few by criminal intent. If so, the assertion above might be reworded as follows:
Despite recognising that capitalism
is only the best of a bad lot,
those who prosper from it, seek to guard their own self-interests.
It is recognised that this may be seen as a very cynical perspective, which ignores the claim that capitalism will advanced the future prosperity of us all. However, while capitalism may work for a minority, it is debatable that it has ever worked for ‘us all’. For it has seemingly created a system where the minority have come to own the means of production, while not producing anything themselves, while the majority have been left owning only the possibility of selling their labour within an ever-changing globalised economy. However, what might ultimately be concluded from this review is that most of the economic problems outlined are not without solutions, but rather problems with solutions that do not serve the self-interest of a powerful minority, such that they continue to be ignored. Whether this situation continues into the future remains to be seen, but probability suggests that any meaningful change will have to come at a price to both the haves and have-nots.
As one final comment, you might want to view this Youtube link that outlines the distribution of wealth in America, highlighting both the inequality and the difference between our perception of inequality and the actual numbers. However, some people attempt to explain many aspects of this distribution, including wealth, with in human society as a natural law based on a Pareto function. While this is undoubtedly true, the key words here are ‘natural law’ that suggests that humanity can have no control on the outcome of this type of distribution. This clearly does not have to be the case in respect to wealth inequality, where human society can regulate the excesses of self-interest, when it borders on greed.