This Cruel Austerity Experiment has Failed

The facts are clear. This cruel austerity experiment has failed

While the human cost of economic stupidity is all too visible, the world's leaders are paralysed by their dogma

• 
• • Will Hutton
  • guardian.co.uk, Saturday 2 June 2012 21.00 BST

A woman receives a free meal from a soup kitchen organised by a Greek humanitarian group in Athens’ main Syntagma Square. Photograph: Kostas Tsironis/AP

Last week was an awesome warning of where go-it-alone austerity can lead. It produced some brutal evidence of where we end up when we place finance above economy and society. The markets are now betting not just on the break-up of the euro but on the arrival of a new economic dark age. The world economy is edging nearer to the abyss, and policymakers, none more than in Britain, are paralysed by the stupidities of their home-spun economics. Yanis Varoufakis, ex-speechwriter for former Greek prime minister George Papandreou and now an economics professor in the US, said last week: "There is precisely zero chance of austerity working. It is the same as thinking you can escape from gravity by waving your arms up and down."

It could hardly be more sobering. Money has flooded out of Spain, Greece and the peripheral European economies. Signs of the crisis range from Athen's soup kitchens to Spain's crowds of indignados protesting in the streets against austerity and a broken capitalism. Youth unemployment is sky-high. Less visible is the avalanche of money flowing into hoped-for safe havens in the US, Germany and even Britain. The last time the British government could sell government bonds at interest rates as low as today's was in the early 1700s.

George Osborne and his acolytes proclaim this as a triumph of the government's economic policies. They are gravely mistaken. Rather it portends fears that the international economic order may collapse because if so many countries are simultaneously pursuing austerity, where's growth to come from?

Virtually everywhere you look there are signs of a weakening world economy. At home, manufacturing suffered its biggest plunge for three years, and this in an economy already suffering its longest depression since the 19th century. American jobs growth is petering out. Unemployment in Europe averages 11%. Even China witnessed a sharp fall away in factory activity in May.

Yet none of this should be a surprise. We live in the aftermath of one of the biggest financial and intellectual mistakes ever made. For a generation the world, with the London/New York financial axis at its heart, surrendered to the specious theory that lending and financial contracts could grow many times faster than the underlying economy. There was a blind belief that in a free market banks could not make mistakes. Free markets didn't make mistakes – only clumsy bureaucratic states made economic mistakes. Or so they said. Financial alchemists, guided by the maxims of free market fundamentalism, could make no such errors.

Except that they did. The result was the financial crisis of 2008. Had governments not underwritten their overstretched banks with trillions of dollars, euros and pounds, an even worse global slump would have ensued. But while the banks could continue trading, the hundreds of trillions of loans and financial contracts they had made did not go away.

And because governments had guaranteed their deposits, as in Ireland, or had to inject capital into them as Spain has been doing all last week, this private bank debt has steadily become public debt. Here is a classic case where all the gains were privatised, and all the losses were socialised. It was the much-maligned state that had to step in and clear up the mess left behind by the private sector. The free market wasn't so free after all – in fact it proved astonishingly expensive for the public purse. People across Europe still pay the price.

This is no solution. Overstretched banks have become more cautious about lending new cash; and even strong banks are caught up in the backwash because if they step into the breach they could fall into a vortex of falling property prices and declining economic activity, becoming weak in turn. So as banks stand aside from their crucial function of generating credit, governments and central banks must step in to generate the demand that has now disappeared.

But they have not done so to a sufficient degree. Part of the problem is that the more bank debt that governments guarantee, the less room for manoeuvre they feel they have – especially as their stagnating economies forces up welfare spending and depresses tax revenues.

But the larger problem is intellectual. The dominant ideology of the day – from the same roots that delivered the crisis – forbids it. A consensus stretching from US Republicans through to Angela Merkel's Christian Democrats via George Osborne's Treasury continues to claim that the state is the source of economic bad. The state threatens enterprise, invites damaging taxation, and is the root cause of spreading inflation. The state must balance the books just as the private sector must.

This is not just an economic but a moral necessity, they argue. Living within one's means rather than "maxing" out on debt appeals to American, British and German individualistic Protestantism. Inflation is even more a sign of moral degradation: it means reneging on promises, rewarding spendthrifts and penalising savers. We had the good years. Now we must take our medicine. The public and private sectors must retrench simultaneously worldwide. Enterprise and free markets will do the rest. The "march of the makers" will step in to fill the void left by public austerity measures.

This is a first-order moral and economic mistake. Human beings need each other for mutual support. In economic terms this means that no individual, either as a person or a company, can manage existential risk by themselves. That risk needs to be shared and mitigated otherwise the risk is not accepted. There would be no enterprise or innovation – the risks of failure too great. That is why there is a role for both private and public sectors. It is governments who provide the means through which we express our social obligations and pool our risks.

This is the heart of Keynesian economics – a different set of moral and economic propositions than those which prevail. Today we can see an almost laboratory experiment on a global scale of why Keynes was right and his detractors wrong. There is no doubt what Keynes would advocate now: a government-sponsored increase in demand co-ordinated across as many countries as possible and an acceptance of a temporary but closely managed increase in inflation to reduce the real value of debt.
The enormous legacy of private debt – whether in Britain, Germany, Spain, the US or Greece – and the fiendishly complicated way so many of the loans have been organised and distributed around the world financial system cannot be easily unwound. Sir Philip Hampton, chair of RBS, warned this week it might take a generation for RBS investors to recover their money.

The choice is thus stark. To commit to decades of economic stagnation, the break-up of the eurozone, the risk of trade protection and autarchic economic policies, the dismantling of the west's social contracts, the imposition of high unemployment and the political fallout that will follow.

Or to change course.

The technical means are relatively simple. Governments must replace targets for inflation with targets for the growth of prices and growth of output combined. Central banks should inject money into their financial systems by offering to buy new bank loans made to support new investment, new innovation or new infrastructure – helped by partial government guarantees.

Governments also need to increase demand. They can do this directly – with targeted and time-limited tax cuts or spending increases. They can also move indirectly, taxing the rich more aggressively and re-allocating the proceeds in tax cuts to those on middle incomes and lower who tend to spend more – along the lines that both presidents Obama and Hollande have proposed. There is also a case for a financial transactions tax – both to raise crucial revenue and to cap the growth and frenetic speed of financial transactions. Finance has become too powerful. It needs constraining.

Will any of this happen? The west is at a cross-roads, and although such proposals will be fiercely opposed by the British, German and American right they need to be beaten back. After all, it is their ideas that have brought us to this pass. It is not too fanciful to argue that the future of western capitalism depends upon how this argument plays out – and how quickly, if at all, there is a change of course.

The European Crisis

By Pepe Escobar

History will register his plane struck by lightning on the way to Berlin, no fancy kisses, and asparagus with veal schnitzel on the menu. This is the way the eurozone ends (or begins again); not with a bang, but a ... lightning strike. Merkollande - the new European power couple drama interpreted by French Socialist President Francois Hollande and German Christian Democrat Chancellor Angela Merkel - is a go.

Trillions of bytes already speculate whether former President Nicolas Sarkozy spilled the full beans about "Onshela" to Hollande - apart from the fact she fancies her glass of Bordeaux. King Sarko also had a knack for making stiff "Onshela" laugh. That may be a tall order, at least for now, for the sober and pragmatic Hollande.

The good omen may be that both do not eschew irony. In the middle of such a eurozone storm, that's a mighty redeeming quality. Then there's that lightning strike on the way to Berlin. Was it Zeus sending a message that his Greeks would have to be protected - or else? Not to mention that Europe is a Greek myth (Zeus made Europa, the beautiful daughter of a Phoenician king, his lover…)

About that German miracle

So now Merkollande has to show results. There's not much they're bound to agree on - apart from the possibility of a financial transaction tax (FTT) which could yield up to 57 billion euros (US$72.5 billion) a year to battered trans-European economies, according to the European Commission (EC).

Berlin is not exactly against it. But Britain, for obvious reasons, is - seeing it as curbing the City of London. The EC, applying some fancy models, has already concluded that a FTT would not be a burden on economic growth; that would represent only 0.2% in total by 2050.

Two members of the troika - the EC and the International Monetary Fund (but not yet the European Central Bank) - along most governments in the EU, now at least admit that some countries, such as Spain, will need more time to reduce their deficits. An FTT in this case would come out handy.

At home, "Onshela" is secure her austerity mantra is popular (61%, according to the latest polls). Yet she lost another regional election last weekend, in heavily urbanized Nordrheim-Westfalen, the fourth largest urban concentration in Europe after London, Paris and Moscow - now suffering from deindustrialization and high unemployment. And this after losing in rural Schlewig-Holstein, near the Danish border.

What's fascinating is that all this had nothing to do with Europe - and the messy fate of the eurozone with the strong possibility of Greece leaving the euro. German voters couldn't give a damn. They are first and foremost worried about their own eroding purchasing power.

So for the first time the Supreme Taliban of austerity, German Finance Minister Wolfgang Schauble, has admitted in public that a general wage freeze - one of the pillars of the new, neo-liberal "German miracle" - should be revised. Even the Financial Times has admitted that consumption in Germany is "anemic". Schauble now says that wage increases might help.

The heart of the matter is that whatever "German miracle" is good for Germany's robust banking and financial system, is not good for a vast majority of its workers. Plus this neo-liberal miracle simply can't be sold anywhere else in the world.

German weekly Der Spiegel did its best to show why [1].

The heart of the "miracle" is - predictably - the deregulation of the jobs market, always against the interests of workers. That implies a tsunami of part time jobs, "non traditional contracts" and sub-contracting. This means masses of workers not eligible for bonuses or participation in profits - coupled with a reduction in retirement payments and pensions. The graphic consequence has been Germany as the current European champion of rising inequality.

Who's in charge here?

It's wishful thinking to imagine some German politician seeing the light, Blues Brothers-style, and suddenly preaching a true European political integration. German regional politics is directly linked to the banking industry - the same banks which had a ball speculating on securities all across Europe, especially in the Club Med countries.

Blaming the eurozone abyss on the irresponsible acts of selected European nations, on their mounting public debt, and even their pensioners, is perverse. The real cause is the ferocious deregulation of the financial system and the worshipping of the God of monetarism. The absolute majority of European political leaders do not have a clue about basic economics. They have been at the mercy of technocrats who could not give a damn about the social and political consequences of their actions.

But now the technocrats are finally freaking out because if Greece, for instance, nationalizes its banks, the Spanish and French financial systems will go bust, and Germany's will be in deep trouble. Once more this is a graphic illustration of how countries across Europe are - in the public as well as the private sector - totally dependent on the financial system of other countries.

The Masters of the Universe in Europe are actually the Institute of International Finance (IIF) [2] a lobby representing the 450 largest world banks. They get a privileged seat on every significant euro-summit. The proverbial EU and IMF "officials" actually ask the Masters how much a country - as in Greece - should pay to get itself out of trouble. Europe's commissioner for economic affairs, Olli Rehn, is a certified servant of the Masters. Obviously the EU leadership will never admit it is in fact controlled by a cartel of bankers.

One currency, 17 debts

It's hard to believe Merkollande can find a way out of this financial labyrinth. We are facing the uber-surrealist situation of a single currency with 17 different public debts - over which the frenzied "markets" can merrily speculate while individual states cannot fight back, for instance by devaluing their currency. It's this set up that has plunged Greece into the abyss - and may do the same with the euro.

Thomas Piketty, a professor of the Paris School of Economics, dreams that Hollande might become the European Roosevelt. That may be as unlikely as Prometheus getting rid of his burden. But at least Piketty identifies the problem; imagine if the Fed everyday had to choose between Texas debt or Wyoming debt - it would never be able to conduct a sound monetary policy (not that it actually does…)

That explains why the European Central Bank cannot possibly be a factor of financial stability. Meanwhile, Europe is left wallowing in the mire of loaning buckets of euros to banks, hoping they will loan them back to individual states; or loaning the money to the IMF, hoping they will do the same.

Into this quagmire comes Hollande with an economic Hellfire missile; he says that instead of loaning at 1% so the banks make a killing loaning to individual states at a much higher rate, the ECB should deal directly with European nations. He wants the FTT - now. And the wants the European Investment Bank to extend credit to companies. And he wants euro-bonuses to finance infrastructure works.

"Onshela" is bound to give him a firm "nein" on all this - except, maybe, the FTT. Because this all implies that these debts are part of a common European debt. That would be, according to Hollande's vision, a conception of Europe true to its construction - less technocratic, less hostage of the God of the market, less constrained by the dogmas of the financial system. Will Merkollande pull it off? Ask "Onshela".

Note:
1. See The High Cost of Germany's Economic Success, Der Spiegel, May 4, 2012.
2. - See here

Pepe Escobar is the author of Globalistan: How the Globalized World is Dissolving into Liquid War (Nimble Books, 2007) and Red Zone Blues: a snapshot of Baghdad during the surge. His new book, just out, is Obama does Globalistan (Nimble Books, 2009).

Neoclassical Dogma – : How Economists Rationalise Their Hatred of Free Choice

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

What if all the world’s inside of your head
Just creations of your own?
Your devils and your gods
All the living and the dead
And you’re really all alone?
You can live in this illusion
You can choose to believe
You keep looking but you can’t find the woods
While you’re hiding in the trees
– Nine Inch Nails, Right Where it Belongs

Modern economics purports to be scientific. It is this that lends its practitioners ears all over the world; from the media, from policymakers and from the general public. Yet, at its very heart we find concepts that, having been carried over almost directly from the Christian tradition, are inherently theological. And these concepts have, in a sense, become congealed into an unquestionable dogma.
We’ve all heard it before of course: isn’t neoclassical economics a religion of sorts? I’ve argued here in the past that neoclassical economics is indeed a sort of moral system. But what if there are theological motifs right at the heart of contemporary economic theory? What does this say about its validity and what might this mean in relation to the social status of its practitioners?

Let us turn first to one of the most unusual and oft-cited pieces of contemporary economic doctrine: rational expectations theory.

Rational Expectations: Irrationality and an Encounter with the Godhead

Rational expectations is indeed an obscure doctrine. It essentially holds that people operating within a market generally act in line with the expectations of neoclassical theory. This tautology – for it is a tautology – can be traced back to Adam Smith’s ‘invisible hand’ which we explore in more detail later on.

But this goes beyond simple tautology. The neoclassical assumptions are themselves especially stringent and seem to be wholly counterfactual to any observer of human behaviour. Rational expectations theory expects people to act, well, rationally. More specifically it assumes that people always act in order to ‘maximise their utility’ and that such actions result in optimal behaviours that ensure that prices are always perfectly in keeping with what they ‘should be’ – that is, an equilibrium price that perfectly balances supply and demand. Prices then become a pristine and perfect measurement; they translate consumer desire perfectly and are beyond question.

Utility maximisation is a strange doctrine that goes right to the heart of rational expectations theory. It assumes that a fixed value can be placed on the satisfaction people derive from the things they buy. It also assumes – implicitly – that people are in some sense aware of this value and that they undertake their actions rationally in accordance with their perception of it.

At a glance this seems outlandish. Take consumption as the most glaring example. Anyone who has ever encountered any sort of marketing knows well that people don’t act in a perfectly rational manner. People often consume in line with what they perceive to be group expectations. Marketers and corporations take advantage of this and use it as leverage to jack up prices on certain goods. For example, are my brand name jeans really worth that much more in tangible terms than a non-brand names pair of jeans? I would say not.

Economists might counter this by arguing that consumers are still acting rationally insofar as their responding to marketers and brand names helps them further their social esteem: it gives them ‘social capital’ and it is this that the marketer is selling. To argue this is to fundamentally misunderstand the psychology of the consumer. The consumer may indeed identify with the group through the consumption of the product, however this is a deeply emotive act – not one in which the consumer cynically calculates that the product might enhance his or her ‘social capital’. It is not a rational response to the ‘social mores’ that the marketer is selling but rather an irrational response triggered by certain stimuli.

Marketers have understood this for nearly a century. Consider the case of a Lynx ad run a few years ago during the World Cup (here is the ad) – note also that Lynx have been running similar ads for years (which presumably means that this campaign has proved so effective that they have no need to fundamentally change it).

There is a certain amount of group identification present in this ad certainly (doesn’t every guy want to be the Don Juan who ‘scores’ all the chicks?), but there is definitely a deeper strata operating here. I don’t think I need to even point this out. The ad says it quite explicitly: ‘Spray more, get more’. This means that not only will you ‘get more’ women if you use Lynx, but also that if you literally spray on more Lynx you will literally get more women – a fantastic assertion.

Look again at the ad. Note how the guy is using an awful lot of Lynx. Indeed, it almost appears as if more women appear as he sprays on more of the deodorant (if one were to be terribly cynical one might read his end reaction in the ad as a sexual climax induced by his extremely liberal use of the deodorant). Anyone who has stood at a bar in a nightclub next to a guy smelling extremely heavily of Lynx will not doubt that this campaign has been at least somewhat effective.

The idea – a classic in marketing – is that not only to tie the consumer to the brand through group identification and the promise of sexual fulfilment, but to actually influence how the consumer uses the product itself. This ensures that the consumer will purchase more of the product because they will consume it faster. To claim that this behaviour is somehow rational is to pervert the English language itself. This behaviour is strongly irrational and those that attempt to manipulate it know this better than perhaps anyone else.

While we won’t go too far into the argument here, these observations can safely be transferred to most of the decisions that people make in all of the spheres dealt with by rational expectations theory. From direct investment to the purchase of stock to so-called inflation expectations, all have a strongly irrational aspect that is often manipulated by institutions for political and economic ends (the amount of institutions attempting to manipulate inflation expectations at the moment is quite incredible).

One example might be that of housing. During the boom years people invested money in housing not just because they might see a profitable return, but also because it became fashionable to own property – while the following clip is from a comedy show, the social observation is a sound one as far as Irish society during the property bubble is concerned. The boom rested not simply on the fact that it became ‘cool’ to own a house (this would be the social identification element as identified in the above clip), but also because being a homeowner has certain emotive overtones (having a family, being free from one’s parents etc.). These social expectations and emotive responses are key components not only in all speculative bubbles, but in all so-called market activity.

The fundamental point here is that people – be they consumers or producers, investors or forecasters – often act in an almost wholly irrational manner; one that is quite open to manipulation. And once we allow for this the very premise upon which rational expectations theory rests upon falls to pieces.
This is all very interesting, but it has nothing to do with theology, surely. Well, it is in the next key tenet of rational expectations theory that we truly encounter the Godhead.

Rational expectations theory assumes that people always operate on a complete amount of information. Economists call this ‘forecasting’ – although they might call it ‘crystal-ball gazing’. They do not assume that all consumers forecast perfectly at all time. However, they do assume that when any forecasting errors are made they are simply anomalies. This paper sums it up quite nicely:

The hypothesis of rational expectations means that economic agents forecast in such a way as to minimize forecast errors, subject to the information and decision—making constraints that confront them. It does not mean they make no forecast errors; it simply means that such errors have no serial correlation, no systematic component.

The idea here is that all economic actors have access to almost perfect knowledge of economic variables over time (prices, inflation etc.). True the above author qualifies that such forecasting is ‘subject to information and decision’** – which is more than many other economists allow – but this is a smokescreen. If we assume that market actors do not make mistakes in a given market then they must, by default, have access to almost perfect knowledge of that market; otherwise, to say that they don’t make mistakes is silly. If they were to have incomplete information then they would have to act, at least to some extent, on their gut instinct and so would, by definition, not be acting wholly rationally.

In rational expectations theory when market actors get market variables incorrect or act in an ‘incorrect’ manner on these variables this error is not taken to be indicative of some underlying uncertainty in their action, but simply an anomaly; an exception to the rule. Economic actors are assumed to have access to near perfect information, not just about the present but about the past and future as well.

Scratch a little deeper and you’ll find that this is an even more incredible assertion than it first appears. Rational expectations theory essentially assumes that consumers are omniscient beings – or at least, when they are acting ‘normally’ they are omniscient. This is where we encounter truly theological motifs in the edifice of neoclassical economics.

In many theologies, God is assumed to have perfect knowledge. And in order to gain access to this knowledge one needs only to try to build one’s relationship to God onto a higher plateau. In rational expectations it is assumed that individuals can indeed make mistakes – in theological terms: they can Sin – but these mistakes are never systemic – in theological terms: individuals are always on the way toward Salvation. As long as the individual keeps with the ‘tenets’ of the theory (which is presupposed), Sin is minimised and the individuals acts in line with the being possessing perfect knowledge.

The being of perfect knowledge is here not thought of as ‘God’ per se, but instead is given the name ‘The Market’. On a purely intellectual level the ideas seem almost identical. Both are overarching principles governing our lives, both are generally ‘followed’ unless perverse deviations (Sinners) crop up and both are perfect information processors.

We will return to this when we pick up Smith’s theory of the ‘invisible hand’ – a theory from which this all stems. For now let us turn to the true neoclassical Godhead: the efficient markets hypothesis.

The Efficient Markets Hypothesis: The Godhead Embodied

As we shall see shortly, ‘the Market’ is and always was a strongly theological idea. However, it is in the efficient markets hypothesis where the Godhead is truly to be located today.

Whereas the rational expectations model of the economic actor assumes that he or she is always in some sort of relationship with a being of perfect knowledge, the efficient markets hypothesis points the way to this divine being itself.

To really boil it down, the efficient markets hypothesis essentially states that all information is always already built into markets and hence they operate perfectly in line with how neoclassical theory would expect them to operate (i.e. with supply and demand in perfect equilibrium and prices reflecting this perfectly). In a way, the efficient markets hypothesis assumes that markets are made up of the actors we previously encountered in the rational expectations model. Since, as we have already seen, these actors always act in a predictable way, a conglomeration of them will process information perfectly.

The question to be asked is of the ‘chicken and egg’ variety: do these theories begin with the rational actor and then build upon this to form the efficient markets theory OR do these theories begin with the assumption of an overarching arena of rationality which is called ‘the market’ and then assume peoples’ actions based on this abstraction?

I would argue that the latter is the case. As we shall later see, if we trace these ideas right back to their roots we find that the theory of markets is far more primal than the theory of the rational individual – the latter is, in many ways, derived from the former.

So what status does this give the being that we call ‘the Market’? Well, if it is a being that is presupposed to exist while only being seen through its effects and is given the power to direct the behaviour of individuals, then it is surely of the theological variety. It is the Godhead embodied.
Many commentators – including this blog’s editor Yves Smith in her book ECONNED – have pointed out that the efficient markets hypothesis was used by policymakers to justify their cutting back on regulations and allowing ‘the Market’ to operate without constraint. These commentators have pointed out that it was this policy prescription that led to the current financial crisis.

It is also to be pointed out that these prescriptions were always undertaken with a kind of faith. Past experiences had cast into doubt that financial markets operated in line with the efficient markets hypothesis and yet those who pushed for deregulation were true believers in the hypothesis; they acted as if they were in a sort of irrational reverie, a suspension of historical remembrance wholly driven by their beliefs. It should not be surprising then that we find this idea to be a very close approximation of certain religious ideas and ideals.

The idea that there might be some overarching being – whether called ‘God’ or ‘the Market’ – that is directing all our activity and through whom we can be sure our actions are just and righteous, is a very attractive one. Like the religious ideas of yore it can both justify our actions when they are ethically questionable – we can assure people that such actions are in keeping with the Market’s Divine Will – and can assure us that the actions we undertake are reflected in and through some higher ideal – in this case a perfectly rational being we call ‘the Market’.

These ideals can also justify our actions after the fact when the God, so to speak, has failed. When this occurs – as has certainly happened today – devotees can assure the general public and their colleagues that it was simply a glitch, perhaps a testing of our faith and that we should never question the Market’s Will. Some of the more extreme devotees might even suggest that we have Sinned too greatly and that we have not followed the Market’s Will adequately enough. More deregulation is needed otherwise we might incur further punishment from the Divine Wrath.

Lying behind rational expectations theory and the efficient markets hypothesis is Adam Smith’s old notion of the ‘invisible hand’ and it is to this we now turn.

The Invisible Hand and Predestination

For by grace you have been saved through faith, and that not of yourselves; it is the gift of God, not of works, lest anyone should boast. For we are His workmanship, created in Christ Jesus for good works, which God prepared beforehand that we should walk in them – Ephesians 2:8-10

It was on this passage of the bible that the famous Protestant theologian Martin Luther based his idea that human beings had no free will. They were always subjects of God, bound up with Him and merely danced to whatever tune he played. This is the essence of the Protestant idea of Predestination. God has a plan for each and every one of us and we are just cogs in his great harmonious machine. It is His invisible hand that controls our actions and our destinies.

The importance of the invisible hand in the work of the first modern economist Adam Smith is hotly debated, since he used the metaphor only three times in his whole work and even then he used it only loosely. However, it is thought by many – and rightly, I think – as distilling the main thrust of his work in a single, useful phrase.

For Smith, the Market should be free to largely act autonomously. It ironed out its own inconsistencies and operated effectively and harmoniously. But what place did this leave for the individual?

Many today claim that Smith was the great prophet of human freedom. Yet if his theories are read as being wholly deterministic this surely cannot be the case. If the Market acts autonomously, unconsciously dictating all our actions then is there really space for liberty in classical or neoclassical economic theory? I would argue not.

The invisible hand permeates all aspects of neoclassicism. In a seminal paper entitled ‘Situational Determinism in Economics’ the philosopher of science Spiro Latsis shows that the whole neoclassical research program relies on an overarching determinism which he refers to as ‘situational determinism’. What he means by this is that, given a certain situation that a particular individual might find him or herself in, they will always necessarily choose one path – their behaviour will always follows a certain given direction.

This is, of course, the invisible hand at work. The person is directed or guided by an invisible force that leads them to undertake one action and avoid another. This should also be recognised as one of the fundamental aspects of rational expectations theory as outlined above: the individual is assumed to always act in a specific way and any other actions are thought to be ‘deviations’.

The invisible hand is truly the hidden thread tying together all sorts of neoclassical theories – from rational expectations to the efficient markets hypothesis. And in this it is simply a reiteration, in quote-unquote ‘secular’ form, of an age old Protestant theological assertion. What we get is a view of a world governed and controlled by a mystical and invisible force that sorts everything out for us. Everything operates without human governance, the world adheres to a set of laws handed down by an invisible agency; everything in its right place. This is Predestination pure and simple.
(It should be noticed that Austrian School ideologue Ludwig von Mises recognised that the invisible hand in Smith was in fact an image of God. He held, however, that secular reasoning led in this direction and did not see a problem with this. One can only assert that von Mises was more self-aware than other believers. See: note 3 on page 147 of Mises’ ‘Human Action’ – an ironic title given the thrust of our present discussion).

In modern neoclassical theory we find this structure operating mainly through the two theoretical postulates discussed in the first and second parts of this piece.

The efficient markets hypothesis postulates that there is an overarching and invisible force that cannot err. This is an image of a God controlling the world and ensuring that order emerges automatically out of chaos. All of us individuals are then conceptualised as living inside of this holy sphere. This leads to the assumptions of rational expectations theory.

In rational expectations theory, individuals are taken to act in the way assumed by neoclassical economics: that is, they rationally seek to maximise their gain in a particular way etc. The theory allows that they sometimes make mistakes, but these are thought of as ‘deviations’ and are never allowed be the norm. The Market, being infallible, omnipotent and unable to err, effectively ensures that individuals are not allowed to make mistakes in any systematic way. To cast this in theological language: God, being infallible, omnipotent and unable to err ensures that individuals are not able to Sin in any systematic way. While Sinning does take place, the overall thrust is for Man to follow the path that God has laid out for him.

The neoclassical paradigm offers its adherents a very attractive theology. It allows them to look at the world through a remarkably powerful set of rose-tinted glasses. It assures them that everything is okay – provided regulators and Sinners don’t get into positions of power – and that order and harmony will be established by an over-arching, quasi-external power. It gives its adherents a being that they can, in a very real sense, worship. It gives them a moral code that they can follow and that they can use to justify their actions, even when these appear to an external observer as being disgusting, idiotic and objectionable.

Dogmatism and Its Dangers

Perhaps this last point is the key one. The most dangerous personality trait of dogmatic religious devotees is their ability to insist that their extreme views are pure truth and that any action they undertake, no matter how destructive and stupid, are always already sanctioned by a higher power.
In his modernist classic ‘Ulysses’, there is a beautiful sentence in which James Joyce sums up the hypocrisy of religious dogmatists who use their fixed beliefs to justify actions that they might not be able to otherwise undertake in good conscience. Speaking of Oliver Cromwell’s brutal military campaign in Ireland in the mid-seventeenth century Joyce writes:

What about sanctimonious Cromwell and his ironsides that put the women and children of Drogheda to the sword with the bible text ‘God is love’ pasted round the mouth of his cannon?

What about him indeed? Such is the epitaph we might one day see on the tombstone of that strange secular religion that is neoclassical economics – although rather than the text ‘God is love’ pasted round the mouth of its collective cannon, there are instead written the words ‘the Market is always right’.

** As we will soon see, the meaning of the word ‘decision’ here is very shaky. How can a deterministic theory which claims to know how people will act allow them to have the power to make a decision? If they have the power to make a decision then, by default, this decision will be uncertain and no overarching theory will be able to capture it. By making reasonable qualifications to accompany an unreasonable theory the above author unwittingly destroys the theory itself.

Growth And Free Trade: Brain-Dead Dogmas Still Kicking Hard

By Herman Daly

11 February, 2012
Daly News

There are two dogmas that neoclassical economists must never publicly doubt lest they be defrocked by their professional priesthood: first, that growth in GDP is always good and is the solution to most problems; second, that free international trade is mutually beneficial thanks to the growth-promoting principle of comparative advantage. These two cracked pillars “support” nearly all the policy advice given by mainstream economists to governments.

Even such a clear thinker as Paul Krugman never allows his usually admirable New York Times column to question these most sacred of all tenets. And yet in less than 1,000 words the two dogmas can easily be shown to be wrong by just looking at observable facts and the first principles of classical economics. Pause, and calmly consider the following:

(1) Growth in all micro-economic units (firms and households) is subject to the “when to stop rule” of optimization, namely stop when rising marginal cost equals declining marginal benefit. Why does this not also apply to growth of the matter-energy throughput that sustains the macro-economy, the aggregate of all firms and households? And since real GDP is the best statistical index we have of aggregate throughput, why does it not roughly hold for growth in GDP? It must be because economists see the economy as the whole system, growing into the void — not as a subsystem of the finite and non-growing ecosphere from which the economy draws resources (depletion) and to which it returns wastes (pollution). When the economy grows in terms of throughput, or real GDP, it gets bigger relative to the ecosystem and displaces ever more vital ecosystem functions. Why do economists assume that it can never be too big, that such aggregate growth can never at the margin result in more illth than wealth? Perhaps illth is invisible because it has no market price. Yet, as a joint product of wealth, illth is everywhere: nuclear wastes, the dead zone in the Gulf of Mexico, gyres of plastic trash in the oceans, the ozone hole, biodiversity loss, climate change from excess carbon in the atmosphere, depleted mines, eroded topsoil, dry wells, exhausting and dangerous labor, exploding debt, etc. Economists claim that the solution to poverty is more growth — without ever asking if growth still makes us richer, as it did back when the world was empty, or if it has begun to make us poorer in a world that is now too full of us and our stuff. This is a threatening question, because if growth has become uneconomic then the solution to poverty becomes sharing now, not growth in the future. Sharing is now called “class warfare.”

(2) Countries whose growth has pushed their ecological footprint beyond their geographic boundaries into the ecosystems of other countries are urged by mainline economists to continue to do so under the flag of free trade and specialization according to comparative advantage. Let the rest of the world export resources to us, and we will pay with exports of capital, patented technology, copyrighted entertainment, and financial services. Comparative advantage guarantees that we will all be better off (and grow more) if everyone specializes in producing and exporting only what they are relatively better at, and importing everything else. The logic of comparative advantage is impeccable, given its premises. However, one of its premises is that capital, while mobile within nations, does not flow between nations. But in today’s world capital is even more mobile between countries than goods, so it is absolute, not comparative advantage that really governs specialization and trade. Absolute advantage still yields gains from specialization and trade, but they need not be mutual as under comparative advantage — i.e., one country can lose while the other gains. “Free trade” really means “deregulated international commerce” — similar to deregulated finance in justification and effect. Furthermore, specialization, if carried too far, means that trade becomes a necessity. If a country specializes in producing only a few things then it must trade for everything else. Trade is no longer voluntary. If trade is not voluntary then there is no reason to expect it to be mutually beneficial, and another premise of free trade falls. If economists want to keep the world safe for free trade and comparative advantage they must limit capital mobility internationally; if they want to keep international capital mobility they must back away from comparative advantage and free trade. Which do they do? Neither. They seem to believe that if free trade in goods is beneficial, then by extension free trade in capital (and other factors) must be even more beneficial. And if voluntary trade is mutually beneficial, then what is the harm in making it obligatory? How does one argue with people who use the conclusion of an argument to deny the argument’s premises? Their illogic is invincible!

Like people who can’t see certain colors, maybe neoclassical economists are just blind to growth-induced illth and to destruction of national community by global integration via free trade and free capital mobility. But how can an “empirical science” miss two red elephants in the same room? And how can economic theorists, who make a fetish of advanced mathematics, persist in such elementary logical errors?

If there is something wrong with these criticisms then some neoclassical colleague ought to straighten me out. Instead they lamely avoid the issue with attacks on nameless straw men who supposedly advocate poverty and isolationism. Of course rich is better than poor — the question is, does growth any longer make us richer, or have we passed the optimum scale at which it begins to make us poorer? Of course trade is better than isolation and autarky. But deregulated trade and capital mobility lead away from reasonable interdependence among many separate national economies that mutually benefit from voluntary trade, to the stifling specialization of a world economy so tightly integrated by global corporations that trade becomes, “an offer you can’t refuse.”

Will standard economists ever pull the plug on brain-dead dogmas?

 
Herman Daly is an American ecological economist and professor at the School of Public Policy of University of Maryland, College Park in the United States. He was Senior Economist in the Environment Department of the World Bank, where he helped to develop policy guidelines related to sustainable development. He is closely associated with theories of a Steady state economy. He is a recipient of the Right Livelihood Award and the NCSE Lifetime Achievement Award

Another balanced perspective on the global economic crisis

By Chan Akya

The trick to flying is to fall ... and miss. Douglas Adams, Hitchhiker's Guide to the Galaxy

Douglas Adams should have been around now, but tragically died a few years ago aged in his late forties (rather than at '42'). If he had been around, perhaps he would have given some wise counsel to world leaders who all seem out at sea in attempting to handle a crisis that wasn't necessarily of their making but almost seems certain to be their undoing.

The weekend saw political parties in the United States failing to agree on a program to adjust let alone cut sharply the country's yawning budget deficit. Alongside, the seventh regime change since the beginning of 2010 in Europe after this week's booting out of Spain's prime minister Jose Luis Rodriguez Zapatero marks yet another chapter of voters throwing not just the baby out with the bathwater, but in this case also the midwife and the entire bedroom. (See The men without qualities, Asia Times Online, October 29, 2011).

Cue the markets pushing Spanish and Italian yields to record levels this week, and even "reassuring" statements from rating agencies about US creditworthiness being shrugged off. The talk in Europe is now when, not if, Italy and Greece leave the euro; speculation has even mounted about the tenability of the French fiscal position.

Meanwhile banks on both sides of the Atlantic are being pummeled into submission with eye-watering declines in share price which the banks are attempting to correct by shedding thousands of employees. The count this year so far is that over 200,000 banking jobs will be lost in the major financial centers of the West - in effect reversing the entire marginal hiring by the industry since 2008. Alongside business sentiment continues to fall, and as companies postpone indefinitely their plans to invest, the job market isn't going to bounce back anytime soon.

Then there is the economic data. European data is no surprise except to those who have been sleeping for a while, but the ugly numbers from US gross domestic product on Tuesday showed declining inventories - exactly the kind of multiplier effect on the negative end of the spectrum that predicts further and sharper economic pain.

Game theory
Politicians in the US and Europe need to be aware of two basic tenets of government:
a. If you are going to bluff, do it big and do it early;
b. If you are going to panic, do it early and do it big.

The unsaid supplemental rule here is: don't do both. This is the reason for the opening quote from Douglas Adams.

Suspension of disbelief is an art form but apparently also broadly applicable to various aspects of modern life ranging from market sentiment to voter angst. There is very little certainty about any initiative, which basically calls for strong confidence in one's ability to achieve something and more importantly in one's ability to convince the other side of one's confidence in respect to the same. For the markets, the common thread is really one of credibility, not of credit worthiness.

Think about this broadly - if the European Union had stepped out and initiated a broad program to buy every unsubscribed bond from Greece, Italy, Spain et al in the beginning of 2010, would any of the problems really have gotten out of hand since then? Instead, they embarked on a series of "limited" interventions, which have been fruitless precisely because everyone knows they are limited.

It's a bit like walking into battle carrying a single revolver - everyone knows you only have six bullets, and once they dodge those you are the one in serious trouble. If on the other hand the other side has no clue about your weapons and ammunition, the battle is most likely won without firing a single shot.

In the end, this is the primary reason for the Keynesian policies of the past three years to have failed utterly. They were simply insufficient, vastly under-estimating the true economic damage wrought by the 2007-8 financial crisis (I really shouldn't be dating this financial crisis, given that it very much continues to this day). This was then a case of bluffing late and bluffing small time. I am of course happy with this failure because, as I argued before, the demographic necessity of the West was to embrace poverty either broadly through inflation or narrowly through significant write-offs in savings and investments.

So much about the Keynesian failures, but how did the Austrian School followers do in their neck of the woods? Not too well I am afraid. Austrian principles such as credit tightening in a crisis, allowing banks and companies to go bust without hesitation were observed in the exception (Lehman Brothers) rather than the rule (countless US and European banks).

Even in the case of sovereign debt, the demands for austerity (Greece) were trivial and the penalties for noncompliance, laughable ("You veel resign Mr Papanderou, ja?"). This isn't the way that free markets work.

If you really wanted to stem the moral hazard tide, the best way would have been to rescue depositors but let the banks go into administration. That would have ended up costing Ireland a fraction of what the country has spent on its banks since the beginning of 2008, primarily to mollify German bankers who had made incredibly stupid lending decisions (see (F)Ire and Ice", Asia Times Online, November 20, 2010) in the first place.

Even in the US, research has shown that in situations where private institutions purchased mortgages at deep discounts from the banks (or more likely from the Federal Deposit Insurance Corporation, which rescued the banks), the turnaround has been palpable. Mortgages have been quickly modified, some useless tenants kicked out while a majority see their payments adjusted to more affordable levels along which they also have upside participation. In contrast, the government-rescued banks still carry billions of zombie mortgages and have simply failed to address them adequately if at all.

This isn't a surprise as the banks invested government bailouts not into their decrepit operations but rather in punting across their fixed-income books, essentially loading up on a whole bunch of underpriced assets. Some of these assets rose in price, but some others have since fallen back over the course of this year.

"Those damn Europeans sold from summer," exclaimed an American banker by way of explanation of his horrific trading losses in the second half of this year. "Yes, but what were you doing with a 30x leverage position on your books in the first place?" I countered, to no avail. "What else could I do - everyone else was hiring in 2009 and management asked me why I wasn't" he replied. That is moral hazard in practice for you. A game of passing the parcel where everyone knows that the parcel contains an explosive device that may be set off by movement, time or just randomly.

The way forward
How do I expect this all to be resolved? This presupposes that I do expect this situation to be resolved in the first place, which I really can't see at this stage. Among all the worst body of options out there, it is my belief that the following combination is likely to produce the most acceptable solution from here on:
1. An unpopular Obama administration attempts to reverse the mollycoddling of US banks going toward the elections. This means a crackdown on banking system leverage, proprietary trading and a long look at jailing a bunch of bankers. This would also involve taking a couple of US banks (you know who you are) to the proverbial cleaners, in essence allowing a controlled bankruptcy of those institutions.
2. Meanwhile the Europeans simply go ahead and commit big time to Keynesian solutions, essentially overruling the German opposition. The European Central Bank indulges in significant and unlimited quantitative easing, while European governments turn their back on austerity.

In this combination, the following market impacts come through:
a. A significant decline in the value of the euro against the US dollar, perhaps approaching parity or worse;
b. A sharp decline in global stock prices followed by a sharp rally next year;
c. Rampant inflation in the Western world that helps to push up commodity prices after the initial decline;
d. Recovery in European sovereign bonds for the short-term.

In every possible way of looking at all this though, I cannot help but admit to a strong whiff of wishful thinking in all this. Oh well, it is Thanksgiving after all.

An Influential Economist admits the wrongness of economic dogma

Stephen King




Monday, 21 November 2011

This week I'm going to take a step back and offer my "Top 10 Beliefs Strongly Held in 2007 Which Now Turn Out to Have Been Hopelessly Wrong".







Belief No 1: Inflation targeting delivers prosperity and stability.



In the late 1980s, central bankers the world over became enamoured with inflation targeting. Scarred from the inflationary excesses of the 1970s, price stability seemed eminently desirable. Yet the single-minded pursuit of low inflation also revealed a remarkable ignorance of earlier periods of economic instability which didn't involve very much inflation, at least not of the conventional kind.



Japan had an almighty financial bubble in the late 1980s yet, relative to other nations, enjoyed a remarkably low inflation rate. The US had extraordinarily low inflation in the 1920s but, funnily enough, the decade ended with the Wall Street Crash.







Belief No 2: Japan screwed up but the West knows better



As an argument reflecting cultural and national supremacy, this takes some beating. The Japanese supposedly failed to do the right things. In particular, they didn't loosen monetary or fiscal policy until it was too late. The US wasn't going to make the same mistake. The collapse in stock prices in 2000 thus brought on a dose of the monetary vapours. US interest rates dropped dramatically as the Federal Reserve tried to prevent "another Japan". The policy worked, but only by ramping up house prices, household debt and the mortgage-backed securities market.



The US now faces a situation perhaps even worse than Japan's. The economy has stagnated, risk aversion has increased, government bond yields have plunged, the budget deficit is out of control, government debt has been downgraded, deleveraging is rife and long-term unemployment has soared.







Belief No 3: Governments don't default



Everyone knew that the emerging nations defaulted like clockwork but that developed nations were somehow different. Surely they would never treat their creditors with such disdain. It just wasn't cricket.



Yet cross-border holdings of capital had risen to unprecedented levels. And, within the eurozone, nations had lost the option of printing money. So we now have a situation where, within the eurozone, southern debtors owe money to northern creditors yet, as a consequence of the financial crisis, don't have a lot of spare cash. No surprise, then, that default has suddenly become a – previously unlikely – option.







Belief No 4: Globalisation is good for everyone



The idea was simple. As economies became ever-more integrated – through the opening up of trade and capital flows – resources would be allocated more efficiently, the global economic pie would get bigger and everyone, potentially, would become richer.



Now that western economies have stagnated, household incomes have declined and pension pots are dwindling, the argument doesn't look quite so clever. The pie has indeed become bigger – largely the result of persistent growth in the emerging world – but it's been sliced up in unexpected ways. Not everyone's a winner after all.







Belief No 5: Equities are a good long term investment



This all went wrong at the beginning of the Millennium. The FTSE 100 peaked just shy of 7,000 at the very end of 1999. That now seems a long time ago. While there's been the occasional big rally since then, the falls have been even larger. Despite the extraordinary deterioration in government fiscal positions across the world, risk-averse investors have preferred to buy Treasuries, gilts and Bunds than equities.







Belief No 6: The emerging world cannot decouple



Oh yes it can. While economic activity in the Western world is no higher than it was at the end of 2007, before the world suffered the full force of the financial meltdown, activity in the emerging world is dramatically higher. Chinese GDP, for example, is about 40 per cent higher than it was in 2007.







Belief No 7: Markets work



Some markets work, others don't. Monopolies and oligopolies can't always be broken up but anyone who's bothered to open an economics textbook knows they don't always deliver the best outcomes for society as a whole.







Belief No 8: Global markets trump national states



This was an extension of Francis Fukuyama's "End of History and the Last Man", the idea that western liberal democracies and market-driven economies had triumphed, paving the way for a new era of commonly shared values and beliefs. Yet, as we've lurched from one crisis to the next, the return of national self-interest has been remarkable, not least in the eurozone.







Belief No 9: House prices always rise



No they don't. This discovery lies at the heart of the problems now dragging down western economic activity through a process of persistent deleveraging.







Belief No 10: Nothing can travel faster than the speed of light



My defence of economists. Yes, we got a lot of things wrong. My profession hardly covered itself in glory. But if the boffins at Cern are proved right, our most fundamental beliefs about the universe may also be wrong. If Einstein couldn't get it right, it merely shows that even the cleverest human is fallible.



Stephen King is the group chief economist at HSBC

Narasimha Rao - The Unsung hero of the India story

by S A Aiyar in Swaminomics

Twenty years ago, Narasimha Rao became Prime Minister and initiated economic reforms that transformed India. The Congress party doesn’t want to remember him: it is based entirely on loyalty to the Gandhi family, and Rao was not a family member. But the nation should remember Rao as the man who changed India, and the world too.




In June 1991, India was seen globally as a bottomless pit for foreign aid. It had exhausted an IMF loan taken six months earlier and so was desperate. Nobody imagined that, 20 years later, India would be called an emerging superpower, backed by the US to join the UN Security Council, and poised to overtake China as the world’s fastest growing economy.



For three decades after Independence, India followed inward looking socialist policies aiming at public sector dominance. The licence-permit raj mandated government clearance to produce, import or innovate. If you were productive enough to create something new or produce more from existing machinery, you faced imprisonment for the dreadful crime of exceeding licensed capacity.



Socialism reached its zenith in the garibi hatao phase of Indira Gandhi (1969-77), when several industries were nationalized and income tax went up to 97.75%. This produced neither fast growth nor social justice. GDP growth remained stuck at 3.5% per year, half the rate in Japan and the Asian tigers. India’s social indicators were dismal, often worse than in Africa. Poverty did not fall at all despite three decades of independence.



In the 1980s, creeping economic liberalization plus a government-spending spree saw GDP growth rise to 5.5%. But the spending spree was based on unsustainable foreign borrowing, and ended in tears in 1991.



When Rao assumed office, the once-admired Soviet model was collapsing. Meanwhile, Deng had transformed China through market-oriented reforms. Rao opted for market reforms too. He was no free market ideologue like Ronald Reagan or Margaret Thatcher: he talked of the middle path. His model was Willy Brandt of Germany.



His master stroke was to appoint Manmohan Singh as finance minister. Rao wanted a non-political reformer at the centre of decision-making, who could be backed or dumped as required. He presented Singh as the spearhead of reform while he himself advocated a middle path. Yet, ultimately, it was his vision that Singh executed.



In his first month in office, the rupee was devalued. There followed the virtual abolition of industrial licensing and MRTP clearance. At one stroke, the biggest hurdles to industrial expansion disappeared. Who was the industry minister who initiated these revolutionary reforms? Narasimha Rao himself! He held the industry portfolio too.



Yet he did not want draw attention to himself. So he ingeniously made the delicensing announcement on the morning of the day Manmohan Singh was presenting his first Budget. The media clubbed the Budget and delicensing stories together as one composite reform story. In the public mind, Manmohan Singh was seen as the liberalizer, while Rao stayed in the background.



Singh initiated the gradual reduction of import duties, income tax and corporate tax. Foreign investment was gradually liberalized. Imports of technology were freed. Yet the overall government approach was anything but radically reformist. When bank staff threatened to go on strike, Rao assured them that there would be no bank privatization or staff reforms. When farmers threatened to take to the streets, Rao assured them there would be no opening up of Indian agriculture.



The IMF and World Bank believed that when a country went bust, that was the best time for painful reforms like labour reforms. However, Rao took the very opposite line. He focused on reforms that would produce the least mass losers (such as industrial delicensing) and yet produced 7.5% growth in the mid-1990s. These gave reforms a good name, and ensured their continuance even when Opposition parties later came to power.



In the 2000s, the cumulative effect of gradual reform finally made India an 8.5% miracle growth economy. Rao got no glory for this. He had lost the 1996 election amidst charges of buying the support of JMM legislators. This led to his exit as Congress chief. Although he was eventually exonerated by the courts, he died a political nobody.



How unjust! He deserves a high place in economic history for challenging the Bank-IMF approach on painful austerity, and focusing instead on a few key changes that produced fast growth with minimum pain. The World Bank itself later changed its policy and started targeting “binding constraints” (like industrial licensing)



Manmohan Singh said repeatedly that he could have achieved nothing without Rao’s backing. Today, 20 years after the start of India’s economic miracle, let us toast India’s most underrated Prime Minister — Narasimha Rao.