Opinion: On The Left - It's Growing, So Kill It!

By Jordan Carter

I was reading the `Business Herald' on Saturday. There was a long article on the Reserve Bank's tightening of monetary policy, and it was a delicious read because it was deeply ironic without the author even apparently being aware of his own irony.

`High hurdles for Brash' was a parable for the flaws of the modern economic approach. It demonstrated better than anything I would have thought of writing the flaws of our orthodox economic theory, which is loosely of the neo-classical school or the Keynesian-Neo Classical synthesis [also known as bastardised Keynesianism].

We are told with the utmost seriousness that the large current account deficit means that the dollar is weak. This means that an appreciation in the dollar that did so much to constrain inflation in the mid-1990's [and also held down growth in the tradeable sector] isn't likely to recur. Therefore, more emphasis will have to go on interest rate rises to constrain inflation. However, the domestic sector is much weaker than in the mid 1990's and housing prices aren't booming as they were then. So, the use of interest rates may well cause a recession in the economy. I think that's irony. The best thing economic policy can do is cause a recession to keep prices from rising.

Fundamental flaws in theoretical systems very rarely have as much of an impact on people as they do when they are in economic systems of thought. A mistake in an obscure branch of geography can be dealt with. Unless it causes a nuclear disaster, so can a mistake in physics. Economics however is a discipline which claims to deal with issues that affect all of us, and in policy terms Governments, motivated by economic ideas, do affect all of us one way or another. The problem we have is that, while perfectly logical, the foundations of the system of economic analysis we use [well, that they use] today are fundamentally flawed.

The first reason for that sickness is the way the models are constructed. While the theoretical core of the neo-classical school is a very tight mathematical construct that is perfectly logical internally, it rests on assumptions that bear no relationship to reality. Stage Two economic students are taught to ignore the gap between the assumptions of an economy where all householders are the same and all firms are small and perfectly competitive, and the messy, muddy reality of the economy that actually exists. All the mathematics in the world can't cover up the gap between the reality and the theory, and the excuse of the lecturers that `it doesn't matter if the assumptions are wrong, as long as the predictions are right' simply doesn't wash with me, or with others.

In my view the second flaw flows on from the first. When you have a mathematical mode of analysis, it's essential that it is grounded in an understanding of the institutional structure of the economy, and the historical circumstances of the economy as a whole. But it isn't. Economic history isn't an essential part of an economics degree. You can get your BCom without having any knowledge of context whatsoever, and just know the models. By abstracting so far away from the reality of our economic life, the models driving economics today by definition can't take account of that history. You can't incorporate, for example, the Muldoon Effect into a mathematical formula. The inevitable result is that economic policy ends up doing very bizarre things, which are logical in terms of the model but nowhere else.

So we have things like the obsession with price stability, and an economics correspondent in a daily newspaper explaining how we may force a real recession on the economy because the dollar is going down so interest rates need to be used to constrain inflation even if that cripples the domestic sector due to its high debt loading and lack of security in employment. We talk too little about the distribution of income, the lack of improvements in the productivity of the workforce, the lack of national savings. Unemployment of over a hundred thousand people is either not noticed, or blamed on those people themselves, rather than being understood as the waste of human and economic potential that it is.

Doesn't that strike you as being just a little bit silly?

I just want to make it clear here that none of the above means that conventional economics doesn't work. It does. We have an economy. It is growing and despite the interest rates increase last week it will continue to grow for at least the next few months, unless the rates continue to rise to stupid levels. The United States economy whose policy is being largely [though not as exclusively as ours] driven by the neo-classical theories has been growing for a very long time. My feeling is that good isn't good enough.

So in our case, we will see rising interest rates squeezing growth out of the economy. No matter that growth is what drives employment, and that stable and high growth encourage the investment needed to improve our incomes and our productive capacity. No matter that raising interest rates actually raises the price of investment, causing inflation itself. The mad, logical system of orthodox economics is quite robust, having failed only in the 1930's. But again, it's not good enough! The catch cry of the Reserve Bank, stripped down to its essence, is `It's growing, so kill it!'

It should be obvious though that we would be able to come up with better policy, and a better theoretical understanding of our economy, if professional economists would lose their obsession with nice, neat and tidy, and ultimately stupid mathematical models, and would instead focus on an economics that was in tune with society. While for some the logical purity of the neo-classical model is irresistible, most economists I think and hope are more sensible.

There is a theory such as I have described, too, by the way. An economics quite outside the orthodoxy, which deals with economic reality instead of fantasy, which is cognisant of history and institutions in the way it analyses economic events. An economics that deals with questions of power and distributions of wealth as important questions rather than irrelevancies.

It's called the Post Keynesian school. And as my reading of it expands, I'll be telling you more.

Till next week,

ENDS

Contact: carters@ihug.co.nz - Jordan Carter - Auckland, New Zealand

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