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The failure of my profession

7 August 2016

I have been meaning to write a post about the state of economics for some time. For many years, I have been unhappy about the increasingly abstract articles in the most prestigious journals (e.g. the American Economic Review, Journal of Political Economy etc.). My PhD is from 1991; yet, today, I do not understand most papers published in those journals. The level of mathematics required to read them is simply beyond me. So we have a group of people publishing for a narrow circle of like-minded academics with absolutely no impact on public policy.

This general malaise is not new, and others have complained about it as well. And of course there are exceptions, people like Paul Krugman or Thomas Piketty or Joseph Stiglitz who write about real world problems in an understandable manner, but still based on rigorous analysis of empirical data and on sound theoretical foundations and methods.

No, what prompts me to write this particular post at this particular time is the increasing influence of populist parties and movements in the Western world. Whether you look at countries where the crisis hit hard, like Spain or Greece, or those where it had much less impact, like the UK or Scandinavia or the USA, you see different expressions of the same phenomenon: an almost nihilistic rejection of the established order, as expressed by Podemos in Spain, Syriza in Greece, the Freedom Party in Austria, the Front National in France, the Brexit vote in the UK and the rise of Donald Trump in the US…I could go on, but the picture is clear: increasingly, large groups of voters in Western democracies are voting for parties (whether on the left or on the right) that promise easy solutions to complex problems and that feed on the general sense of betrayal felt by those voters.

So, who are those voters and why do they feel betrayed? A big part of the answer lies in the globalisation that we have experienced in the past few decades and the failure of the political system to deal with its consequences. The Economist had an interesting article about this in early July, summarising the work of economists such as Dani Rodrick of Harvard, who question the consensus about the inevitability of globalisation and free trade.

Let us take a step back, to the birth of the economics profession in the late 18th century and early 19th century. The two significant names are of course Adam Smith who explained how society gets richer if everyone focuses on work that s/he is particularly good at and on the importance of the profit motive (“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 self-interest.”); and David Ricardo, who took Smith’s analysis further and extended it to international trade.

Adam Smith is often regarded as an ultra-liberalist who advocated a minimalist state, letting Darwinian capitalism rule otherwise. This is a complete misunderstanding of his ideas. In The Wealth of Nations he recognises that business owners will team up to take advantage of the consumer if the government does not prevent them from doing so, and more generally, there are many quotes in his writings to which progressives can sign up to without reservations. For example, the following two quotes clearly show that Smith was concerned about inequality and was in favour of a progressive tax system:

“No society can surely be flourishing and happy of which by far the greater part of the numbers are poor and miserable.”

“It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.”

In his 1817 book, On the Principles of Political Economy and Taxation, Ricardo formalised many of Smith’s concepts and formulated the main principle of international trade theory. Using a simple example of two countries and two goods, he showed that even if one country is better at producing everything than another country, both countries are still better off if they trade, with each country specialising in the products where its superiority is relatively greatest (this is what we call “comparative advantage”). By doing that, consumers in both countries get at least as much of each of the two goods than they do in a situation without trade. This fundamental insight is behind all subsequent trade theory. Later researchers have developed the theory further to take into account various complicating factors from the real world, but the  principle of comparative advantage remains the basis of the economics of international trade.

So, if trade (and the associated globalisation of supply chains, finance, etc.) benefits everyone, how come large portions of the electorate are turning against it? The latest WTO-sponsored round of international trade talks, the Doha Round, which began in 2001, is basically dead, and the future of other major trade deals, such as the Trans-Pacific Partnership, the Trans-Atlantic Trade and Investment Partnership (TTIP) and even the EU-Canada free trade agreement is in doubt. I will argue that at least part of the answer is the intellectual failure of the economics profession to deal with the real world consequences of globalisation.

When we economists say that trade and globalisation benefits society, what we really mean is that in aggregate, society benefits. As consumers, we all benefit from the lower prices we pay for our electronics, for instance, now that manufacturing of such things takes place mainly in low-cost countries, first and foremost China. But it does not mean that everyone benefits. Clearly, there are losers–namely the workers who lose their jobs because making stuff in rich countries is too expensive when competing against the likes of China. This is not new. We have known it all along. The implicit assumption behind the near unanimous support for trade liberalisation among economists is that the winners compensate the losers. In other words: since the aggregate gain from trade is positive, there is room for the winners to compensate the losers and still be better off. This is undeniably true on the level of calculation. Unfortunately, in the real world, the losers have not been compensated. Instead, the winners simply keep the gains to themselves and smugly tell the unemployed steel worker that he must acquire new skills so that he can perform the higher value-added tasks that are needed in the new economy.

With a few exceptions, we have ignored the rise in inequality since the 1970s. Until recently, the only people who worried about it were inconsequential left wingers. Today, the situation is changing. Even the quentessential establishment organisation OECD, often referred to as “the club of rich countries”, is increasingly concerned about inequality and its social consequences. Hopefully, during the coming years this concern will lead to some policy changes. But meanwhile, out there in the real world, those people who have not gained from the economic changes of the past decade have concluded that they have nothing to lose and are rejecting the established order. They are doing it in diffuse ways. This is not an organised revolutionary movement of the sort Marx would have imagined. Sometimes the anger is expressed on the left, as in Spain or Greece; sometimes on the right, as in France; and sometimes in ways that are completely nihilistic and impossible to fit into the left-right catorisation, such as the rise of Donald Trump in the US or the vote to leave the EU in the UK. What these political forces have in common, however, is a desire to turn inwards and even to reverse globalisation, exemplified by Trump’s promise to cancel the North American Free Trade Agreement with Canada and Mexico, to deport 11 million illegal immigrants and to build the wall on the US-Mexico border. Whether or not he will be able to carry out these promises if elected is irrelevant; what is important is that the people who vote for him, or a large proportion of them, anyway, either believe in these promises or at least are looking to Trump to “shake things up”, whatever that might mean.

So I finish with a plea to my fellow economists: worry less about equations and more about describing and analysing the real world, including the political consequences of economic developments. I, for one, am no longer convinced that globalisation, given the political context, has been a good thing.

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