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Economists and the Powerful

Convenient Theories, Distorted Facts, Ample Rewards

Wimbledon Publishing Company

THE ECONOMICS OF THE POWERFUL

All professions are conspiracies against the laity.

— George Bernard Shaw, 1906

The lack of explicit consideration of power in modern mainstream economics is odd. Mainstream economics is built around the theme that people impersonally use their resources to achieve their goals. No one seriously denies that power is an important goal for many people, so why then would the theory of the acquisition and use of power not be a core part of economic theory, especially given that power relations and hegemonics are a core part of most other social sciences? A look at the history of economic doctrine reveals that power was not always absent. It dropped from the radar screen at some point; or rather, it was erased.

This chapter will examine how we got from an economic science that treated relative economic power as an important variable and regarded the resulting income distribution as a core issue of the discipline, to a science that de-emphasizes power and does not want explicitly to deal with distributional issues. The reader should not expect a history of economic thought in general from this chapter. Rather, it is concerned with the dogmatic shifts that led to the current mainstream, which dominates textbooks and policy advice.

Three developments were particularly important. The first was the triumph of marginalism in the second half of the nineteenth century, which allowed economists to appear to have the power to predict the future using numbers just as a hard science like physics might. The second was the so-called "ordinalist challenge" – a dogma imposed starting in the 1930s that forbade the comparison of preferences or utilities between different people. Finally, there was the rational choice movement, which gained prominence in the 1950s and served to discredit any kind of group action or even religious faith as being irrational and destabilizing. Each of these dogmatic revolutions had a sociopolitical or geopolitical role to play. One of these roles was the intellectual defense of the capitalist system against the threat of communism. As this confrontation morphed into the Cold War between the capitalist West and the communist East, economic science became a tool in the geopolitical arsenal of the dominant nation of the West, the United States.

The problem with using economic science as a weapon in an ideological war is that as a result it has become driven further away from helping society better understand itself. Since the end of the Second World War, the US has been able to control the way in which economic success is measured and to promote an economic science that makes the economic model of the United States appear better than any other. This, especially in the past decade, is beginning to look like self-deceit: the relative power of the United States within the world has begun to wane, but the methods by which the numbers are calculated have been modified since the 1990s to show less of a decline than under previous calculation methods. One must wonder if it is wise for the United States to pretend that its decline is not as substantial.

IN SEARCH OF POWER LOST – A BRIEF HISTORY OF ECONOMIC DOCTRINE

Facts do not enter the world in which our convictions live, they have not caused them, and they cannot destroy them.

— Marcel Proust

Pre-classical economists from the fifteenth to the seventeenth century had a viewpoint very different from the current individualist bent. The perspective and interests of the state and of the emerging merchant class dominated. Early protagonists of this statist school of thought, the Bullionists, were concerned with maximizing the amount of gold and silver coins circulating in the national economy, as they considered this the basis for a high tax base and profit base. They wanted to keep imports down and promote exports. At the time, all economists were aware that gold was an important means to achieve wealth and power, and that wars were won with gold (Screpanti and Zamagni 1993; Reinert 2007). Later, a more refined and generalized form of mercantilism emerged, which distinguished between kinds of goods. Raw materials and unprocessed food were to be imported freely, as these could be used to produce industrial goods with high added value. Exports of raw materials were discouraged or prohibited, with the twin goals of making industrialization harder for competing countries and of promoting usage of these raw materials in local industries. High tariffs on imports of industrial goods served to protect the domestic industry against foreign competition. These policies were widely pursued in Europe in the late sixteenth and seventeenth century, including, most notably, England (Screpanti and Zamagni 1993; Reinert 2007). And if such an export-orientated policy sounds familiar today, it is because China and Germany (in the guise of the EU) have recently been using similar policies to gain advantage against all others in industrial production with great success.

HOW POWER WAS PURGED FROM INTERNATIONAL ECONOMICS

However, after Britain had obtained the position of industrial world leader, classical British economist David Hume (1711–1776) fiercely criticized mercantilist theories and politics as unreasonable. He and his famous compatriots Adam Smith (1723–1790) and David Ricardo (1772–1823) became champions of global free trade. They agitated against continental European attempts to grab market share from the leading economy using the same mercantilist policies that Britain had so successfully employed before. Even so, it was not easy to convince other countries that it was best for them to continue exporting raw materials to Britain and importing industrial goods back from Britain. Thus England often used her supreme military power to back up the message of the economists. England explicitly prohibited colonies from engaging in manufacturing. Their negotiation strategy with weaker countries was to adopt treaties that forced the weaker country to deliver raw materials for English industry and to provide open markets for industrial goods from England, thus ensuring that the native industries of the weaker country were put out of business. One of many examples is the Methuen Treaty of 1703–1860 with Portugal (Reinert 2007). This treaty granted a one-third reduced tariff import of Portuguese wine into Britain in exchange for tariff-free import of British cloth into Portugal. This placed the Portuguese cloth industry in direct competition with Britain's vastly larger cloth industry, which was technologically more advanced and had significant economies of scale, and thus could produce cloth at much lower prices. In exchange, Portugal gained free access to British ports throughout the world, which was a boon for its traders, who were able to resell British manufactured goods with a much better profit margin than their French or Spanish counterparts (and Britain did not try to seize Portugal's Brazilian colonies, unlike those of Spain or France). Ricardo would later use this treaty as his famous example to illustrate the mutual benefits of comparative advantage (Ricardo 1817); however Portugal to this day still lives with an unusually global-trade-dependant economy as a legacy of that treaty (Almodovar and Cardoso 1998).

THE BIRTH OF MARGINALISM

While the classical economists touted the virtues of free international trade and took issues of power out of international economics, they still left some room to discuss power in the national context, notably on the labor market. When Adam Smith wrote his famous Inquiry into the Wealth of Nations in 1776, large parts of the British population hardly had enough income to feed their children adequately and provide decent housing. For Smith, it was clear that wages were determined by the relative bargaining powers of industrialists and workers:

What are the common wages of labour, depends everywhere upon the contract usually made between those two parties ... The workmen desire to get as much, the masters to give as little as possible ... It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily, and the law, besides, authorizes, or at least does not prohibit their combinations, while it prohibits those of the workmen ... In all such disputes the masters can hold out much longer ... Though they did not employ a single workman, [they] could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week. (Smith 1776/2007)

The introduction of marginalism in the second half of the nineteenth century helped to take discussion of power out of domestic economics. An important ingredient was marginal utility theory, which German statistician Hermann Gossen (1810–1858) first presented in 1854. His main theorem says that the more we consume of a particular good, the less additional or marginal utility we derive from any additional unit of the good. Gossen's work was not well received and very few copies were sold (Screpanti and Zamagni 1993).

It was only in the 1870s that William Stanley Jevons, Alfred Marshall, Carl Menger and Leon Walras triggered the marginal revolution in earnest. A self-confident and wealthy class of industrialists could make good use of a theory defending the virtues of a free capitalist market economy against Marxist assaults and socialist tendencies. Karl Marx had just published Das Kapital in 1867, and the Marxian labor theory of value, which built on classical value theory (that value comes from production, i.e. natural resources and the labor which transforms them into products), made the claim that capitalists exploited laborers.

To combat Marxian theory and its followers, industrialists had to argue against the classical theory of value. This was quite urgent for all those interested in preserving the status quo against revolutionary impetus. The International Workingmen's Association, also called the First International, was inaugurated in London in 1864 and held important congresses in European capitals between 1866 and 1872. In 1889, the Second International, strongly influenced by Marxism, was founded in Paris. There were violent repressions in Britain, Germany, the US and Italy in the 1870s (Screpanti and Zamagni 1993). Those who owned the capital were extremely aware of the potential threat.

The theory of marginal utility could challenge the theoretical foundations of socialism without being openly ideological, and therefore have the appearance of being "scientific" and value-free. While classical economists had explained prices with the costs of production, the marginalists switched the focus to a consumer perspective. This new approach explained prices and quantities by utility or usefulness for consumers (Screpanti and Zamagni 1993). This was an odd switch at an odd time, given that it occurred during the Industrial Revolution, when production technologies were changing dramatically. One would have expected that the production sphere would become increasingly central to theories explaining what was going on in the economy.

At the center of the Marginal Revolution was the notion that available goods are allocated to the uses and users with the greatest marginal utility. At the same time as the early marginalists de-emphasized the production side, they also eliminated the element of social interaction as best they could. Their examples featured self-reliant people like Robinson Crusoe, who had to decide how to use a given stock of goods, like an allotment of grain. If they produced, they were the producer and consumer all in one, not opening up any possible discussion of how the proceeds from production were shared. Thus economists began to divorce themselves from the pressing socioeconomic problems of the era. They took the focus away from social phenomena and put it instead on the individuals as the "atoms" of society (Screpanti and Zamagni 1993).

Within this artificially simplified framework, and with a number of auxiliary assumptions, the marginalists showed that the allocation of goods and means of production would be optimal in a free market economy. All prices and quantities would be such that the economy was in equilibrium, and workers would receive the fair value of what they produced with any additional hour of work. This result was the core of the neoclassical defense of capitalism against the Marxist charge of exploitation (Screpanti and Zamagni 1993).

In the US, the principal protagonist of this line of thought was John Bates Clark (1847–1938). When Clark derived his theory of distribution, he was urgently aware of its political implications, as can be seen from the following quote from his influential book The Distribution of Wealth: A Theory of Wages, Interest and Profits, published in 1899:

Workmen, it is said, are regularly robbed of what they produce. This is done by the natural working of competition. If this charge were proved, every right-minded man should become a socialist.

This quote may explain why his new theory was met with such enthusiastic support and had such lasting impact, despite a few rather fundamental shortcomings and contradictions that we will further explore in Chapter 4. His theory says that the workings of the market make sure that workers and capital are paid exactly what they contribute to the value of the product at the margin, i.e. by what they contribute to the last unit of the good that can gainfully be produced (Clark 1899/2001).

Finding market-clearing prices for goods, labor and capital is tricky both in theory and reality. They have to be found not only for each market separately, but for all markets at the same time. Leon Walras (1834–1910) was the first to tackle this problem. He formulated a large number of equations describing the whole economy. He was able to show that the system could have an equilibrium. However, he had to realize that there was no guarantee that any equilibrium would be unique and stable. This has remained the rather unsatisfactory state of affairs, even though the equilibrium-loving economic mainstream has been rather successful at concealing or ignoring it (for example, examination questions given to economics students always assume that there are known and stable points of equilibria, and the only problem to be solved is how best to move an economy from one known point to another known point) (Screpanti and Zamagni 1993).

What Walras offered instead was a theoretical method for finding the equilibrium if it existed. It was a process of trial and error by a hypothetical research firm, which he called the auctioneer. The auctioneer would poll people about how much of the various goods they would demand and supply at particular prices, without actually trading at these prices. Whenever demand exceeded supply at a particular price, the auctioneer would raise that price a bit and run all equations again until he found the equilibrium. This is only a theoretical solution, though. In reality, the market will not necessarily find this equilibrium because there is always trading going on at the wrong prices. This trading at off-equilibrium prices can take the economy away from the equilibrium and there is no guarantee that equilibrium will be reached or that it will be optimal in some sense (Screpanti and Zamagni 1993).

Nobel Memorial Prize winners Kenneth Arrow and Gerard Debreu later were able to prove that under certain conditions a unique equilibrium did exist (Arrow and Debreu 1954), with these conditions later taking the unwieldy moniker of the "Sonnenschein–Mantel–Debreu theorem" better known to postgraduate students as the "SMD conditions." However, this proof of equilibrium should rather have been recorded as proof of its non-existence because the conditions are extremely demanding and hardly ever fulfilled in reality. Moreover, how they view human beings and the free market says much about the field of economics in general. For example, all consumers have identical tastes and preferences (i.e. are identical clones), each is perfectly selfish and rational (i.e. is a robot), and each has perfect knowledge of all possible future market prices (i.e. is substantially omniscient), while all firms produce identical goods and services and make zero profit, and there are no transportation or transaction costs. Perhaps coincidentally, much of how globalization has been implemented and justified by economists during the past decades seems to assume that just such a worldview is true.

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Excerpted from Economists and the Powerful by Norbert Häring, Niall Douglas. Copyright © 2012 Norbert Häring and Niall Douglas. Excerpted by permission of Wimbledon Publishing Company.
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