Economists and free markets

 There’s another reason why politicians are motivated to cut taxes, and to look towards privatisation, outsourcing and market-based solutions to problems. It’s because that is what most of the experts recommend.

Dr Tim Dexter, my laté-drinking, bike-riding, sensitive new-age former lecturer at university, is one of those experts. To him, it is without any doubt whatsoever that free markets are better, that governments are inefficient, that lower prices — and lower wages — are better. Industrial relations law must always be flexible. Taxes must always be low. Free trade is definitely better, always. Monetary policy is used to ‘manage’ the economy. Inflation should be kept at zero if possible. Government regulations interfering in the workplace should be abolished. Free competition fixes every problem.

Old-fashioned beliefs, similar to dogmatic religious beliefs, in the magic of the free market, and no influential or powerful alternative view, have trapped us into a pattern of implementing ineffective cost-cutting and similar economic strategies.

Dr Dexter grew up in Brisbane. He attended Brisbane Boys College and later graduated from the University of Queensland Business School with a Bachelor of Economics. He is gay, and his friends call him homo economicus. He wears a suit and black, thick-rimmed glasses, and has a long fringe that he brushes to the left. He’s very tall, so he’s usually looking down at people when he speaks at them.

Dr Dexter is in his late 30s and did his PhD on the applicability of game theory to reforming the taxation of superannuation assets. I’m very jealous of how confident he is in his opinions about economic policies. Economic axioms roll fluently from his mouth like a devout Christian reciting their favourite biblical passages.

On the other hand, what’s the economic alternative? Surely not communism or socialism? Not that we know actually the difference between those things, of course. Former British Prime Minister Tony Blair and British sociologist Antony Giddens would have us believe that the only alternative is a milder, more leftie-pinkie version of Dr Dexter’s orthodox opinion.

It’s usually assumed, in the Western countries, that the alternative to free-market policies is ‘big government’, with high taxes. It’s a vague concept, but when Dr Dexter calls it communism it certainly sounds bad. I know I don’t want to live in an oppressive Chinese-like state.

It is assumed to be logical that we don’t want that, because low taxes are always better — except when you compare Sweden and the United States and quickly realise where you’d rather be living. It’s usually assumed that the only alternative to free market policies is ‘protectionism’; in other words, imposing tariffs on imports to prevent competition from overseas products.

In the 1990s it became cool to predict the death of the big government model. Looking back on the European economic crisis starting since around 2010, a casual look might tell you this is plausible. In any case, in the 1990s a lot of politicians and political parties that once called themselves socialists moved to a more politically centrist, free-market economic policy position.

New Zealand was the star of the free marketeers’ show during the 1980s and 1990s. It privatised government assets, it set about inflation-busting so that inflation was close to zero, two per cent at the most. It was the result of a political system where governments could control parliament and had near-despotic abilities. Voters hated it so much that they pressured to change their electoral system to a proportional, German-style model of representation.

At the same time, authors such as Linda Weiss were looking towards Asia. Her 1998 book, The myth of the powerless state, argues that economic development policies were the best alternative to free market policies in the globalising era.¹⁵ The Asian alternative was not protectionism, it was government interventions to help build new industries. It wasn’t only about government subsidies and giving big business easy money, unless there was a quid pro quo. It was not a model based upon competition; in fact it encouraged cooperation. Since 2000, these are exactly the policies being implemented by governments in various countries to help create the next new wave of investment in green technologies.

Many Asian economies have developed rapidly since World War 2, first Japan (which had been developing since a long time before the war) and then others such as South Korea and Taiwan. In the last two decades, the most remarkable economic development story is Singapore.

Singapore has transformed from a developing economy to one of the top five richest countries per capita.¹⁶ The country has what economists technically consider to be full employment, with an unemployment rate of around two per cent. The Singapore model of economic growth promotes a very high savings rate. It also has a form of government planning because more than half of the economy of Singapore consists of government-owned companies. It also has a very low apparent rate of taxation, at 15 per cent of GDP, although strictly it might be hard to compare its tax rate with countries such as America which pursue largely free-market economic policies. The Singaporean government has a very clear economic strategy focused on export-led development of its industries.

The success of the Asian and Singapore models is impossible to ignore. Yet somehow most economists like Dr Dexter in Western countries manage to ignore it, and keep on arguing for the free-market approach to government economic policy. They are like horses wearing blinkers. They keep holding on fast to their free market fundamentalist ideology, even after the free market disasters in America and Europe since 2007. I guess that’s what fundamentalists do, though, they hold on to things.

In 1999 when the Labour Party was elected as the new government of New Zealand, they didn’t ignore it. The government tried to replicate the Asian model by implementing an economic policy with what it called the Growth and Innovation Framework.¹⁷ By around 2005, however, it became clear that these policies weren’t being implemented successfully. Original high hopes faded into nothing. The main reason seems to be that public servants in New Zealand did not have the skills or training to understand what these policies really meant, or how to go about implementing them.

New Zealand public servants had been scarred by almost two decades of extremist free market policies, and they knew little else other than free market-type solutions for their economic strategies. The bureaucracy was a mix of Dr Dexter and Peter types.

The New Zealand government’s original plan sought to develop its biochemical, forestry, information and communications technology, food, and design industries. Its ambition was to emulate the Asian strategy to develop specific industries. The result was a suite of minor policies aimed at increasing tax incentives and other incentives for companies in these industries. In other words, they tried to implement an Asian model, but forgot not to do so by using free-market-based approaches. The strategy came to almost nothing in the end.

The lesson from New Zealand might be that, while the Singapore and Asian model works in authoritarian countries, it might be more difficult to make it happen in democratic countries, mainly because there are political pressures from business or economists like Dr Tim, who have political influence. In countries like Singapore or other non-democratic countries, these free-market advocates would simply be silenced or disregarded, in a way that is not possible for politicians in Australia or other democracies.

On the other hand, it could just be that these models didn’t work in New Zealand for similar reasons to the ones I have listed in this book: public servants without the right skills; politically influential business, lobby groups and free-market think tanks; and government politicians that cannot but spend too much time in the media sideshow trying to make sure they get re-elected. The Singaporean government doesn’t have to worry about democracy and elections, it can do what it wants. But, then again, when you can achieve economic growth like they have, perhaps the Singaporeans might come to the conclusion that there is a positive side to that?

My question is this. I am happy to let people come to the conclusion that market-based economic policies are best if they want. But the fact remains that most of us — including politicians, public servants, journalists, voters, businessmen, and most economists — aren’t informed about the alternative economic policies that have been so successful in other countries. That’s why free market economists are always dominant in any debate. It’s why Dr Dexter’s words roll out of his mouth like a ball being pulled down a hill by gravity. His logic has been well rehearsed through centuries of economic rhetoric from Adam Smith’s The Wealth of Nations and ever since.

The logic of free market economics is very simple. Which makes it easy to understand, but far too simple to actually match reality.

As a general rule, free market economics has had the run of the world. They’re like a football team that is so well practised they perform their skills like masters. Non-free-market economics, the most experimental of experiments, has had one real practice, the years after World War 2 until the 1970s. The argument between Dr Dexter and anyone who suggests the opposite, is like a football team that’s been practising all season playing against a team that was formed last week.

Sure, you could make an argument that in the West we are freedom-loving, and that’s why we prefer markets over ‘excessive’ government regulation. But then the absence of regulation was exactly the cause of economic recession in America after 2007. We may choose free markets or prefer them, but it’s a very uninformed preference we have for them if we aren’t educated about the possible alternatives.

And I, for one, rule out socialism, communism, protectionism and economic planning as viable alternatives. These things are ‘straw men’ alternatives. In other words, they are not the best alternatives, as represented by Germany, Singapore or Sweden.

The consequences of the dominance of free market economics are huge, and they infiltrate almost every other area of government policies that cost money. In America this dominance has meant that they have not had a universal health care system, which is sometimes labelled a ‘socialist’ or ‘communist’ aim.

Economists like Dr Dexter are a funny breed. Once upon a time I enrolled in an economics degree, and even completed most of it. But then I realised that they don’t actually study economies. It’s a funny thing, and you’ll be tempted to disbelieve me, but it’s true. They don’t study how economies work, they only study how free markets work. Very rarely do economics students take classes in comparative economics, studying different economic systems around the world.

If you doubt this, find an economics textbook from a library or bookshop and take notice of what’s actually in it. There’ll not be a discussion of people running their businesses in the everyday real world, or how Western economies differ from Asian economies, or the history of economics. What you’ll see is mathematical, algebraic equations and hypothetical, theoretical graphs. You’re also very unlikely to see any actual data or focus on empirical evidence.

Economics is a field dominated by amateur mathematicians, ones who don’t actually open their eyes and look at the real world. You may be stunned to learn that economics academics and researchers rarely complete empirical research. They are more like philosophers, using extreme logic to rationally and hypothetically solve problems. They don’t study how actual economies work. Instead they focus on the rational logic behind the price mechanism, supply and demand dynamics, and competition theory.

It is strange that economists often like to think of themselves as social scientists, yet they rarely undertake empirical research. You can't be a scientist if you don't do empirical research.

Interestingly, the logic behind economics produces a popular theory among economists that ‘supply creates its own demand’. In essence, this means that all products and services made will be sold in the market. The theory is that if demand for a product is low, the price will fall until the price is low enough that it becomes attractive for buyers. In theory, according to free market theory, all goods and services should sell. Evidently, most economists are unaware of how much food supermarkets throw out each day. Evidently, most economists are unaware that Australian booksellers buy books from publishers on a returns basis, so that they can return them to publishers if they don’t sell. Economic theory simply doesn’t explain how our economy actually works.

These comments are all water off a duck’s back for Dr Dexter. He is likely to argue something about how the price of a product or service is based on a balance between the quantity produced at any given price and the preferences of those with available cash purchasing power at any given price. As he says, in this situation there is always a positive shift in demand up the demand curve resulting in an increase in price and the quantity sold.

In general, economists have encouraged governments to run the public sector like it is a business, with business principles like outsourcing and tendering of government services now normal. Government-owned corporations or businesses are encouraged to make a ‘profit’, like a business.

Most of all, economists want overall government spending to be as low as possible. This means that governments are often stingy in its spending on education, health, infrastructure and other areas of government spending.

The flip side might seem to be that there is pressure on governments to be efficient in their spending. But if you have ever worked in the government you probably know that this isn’t what happens. Public servants like Peter guard their budgets closely, trying every trick in the book to prevent budget cuts. The whole budgeting game means that Peter is constantly watching his budgets to make sure he is spending enough. If he doesn’t spend all of his budget, it is possible that it will be cut for the following year. With Peter, in the months leading up to the end of the budget year there was always a race to spend more. It was always the time when that new office photocopier or new cupboard came, that’s for sure. Engaging consultants at this time is also a quick way to spend a lot of money fast.

What the determination to minimise government spending more often results in is not efficiency but money and resources not being invested in places where they really are needed. The next time you’re waiting for a long time on a hospital waiting list, or wondering why public transport fares are so high, ask yourself this question: is the free market agenda responsible?

Free-market-focused governments often look to reduce government spending when they get into office. Following the sovereign debt crisis, countries in Europe have been aiming to cut spending dramatically. Government cuts may involve reducing public service jobs or slashing budgets for some programs.

But consider Sam. She’s at the top of a very big organisation. If she was a minister wanting to make huge cuts, how would she judge which business areas to cut funds from? Won’t she be using guesswork? Will she not be making arbitrary choices? Could this not be part of the reason why governments aren’t effective, because in the desire to cut expenses, some important government functions will be underfunded, while Peters everywhere guard their little areas and argue like all hell that their budget shouldn’t be cut.

Of course, many will disagree with the arguments within this chapter. You might disagree with me, too. Dr Dexter’s position is well argued and coherent. It’s just that I don’t agree with it. For me, I feel like this is one of the top ten reasons why government policies don’t work. I think it is a mistake to always treat the public sector like it is a business. I think it has different goals and priorities. But you are free to disagree.

Whereas economists like Dr Dexter spend a lot of time studying how free markets work, I wrote this book because I’m concerned about how the other third of the economy works. Even if you want small government, you still want that government to work well.

 

Unlike most other areas of politics, there is only a relatively narrow debate about economics issues. The matter is largely the domain of right-wing, free-market economists or businesspeople. Often there’s very little debate from any alternative. This is quite a shame. If there is no serious public debate over economic issues, how will we challenge ideas and improve? I always enjoy having people challenge my ideas about the world, because it allows me to strengthen, correct any wrong views I have, and grow.

As a general rule, left-wing young people do not study economics, they vacate the ground for more business-minded people. That’s a shame, for both sides of the political fence, because there is no significant debate pushing the field of economics forward. Of course, I have been criticised before for saying there is no left-wing debate on economics. There is lots of research and opinions, but they are treated as looney and are marginalised. Except in Singapore, Germany and other countries who don’t follow the Anglo-American, free-market model.

 

So what is the alternative? To be realistic, this is a topic for a whole other book, but it is possible to discuss it briefly. Linda Weiss argues that rather than governments focusing on free-market solutions for all economic matters, they should focus on building their capacity to intervene in the market, and help companies overcome barriers to expansion and further investment and profits.

Weiss argues that capacity is judged according to a government’s competency in governing the process of industrial change, as some industries such as information technology and green energy replace older industries:

[State capacity is] the ability to coordinate industrial change to meet the changing context of international competition.

 

[State capacity] is thus the capacity to devise and implement

policies that augment a society’s investible surplus, as opposed to merely redistributing existing resources...’.

 

Weiss sees increasing overall wealth and redistributing wealth as complementary rather than competing objectives. A government’s economic policy capacity depends upon the public sector’s ability to anticipate and respond to economic change. It needs public servants who are highly skilled in developmental economic policy.

It is the capacity for mobilising a ‘collective investment effort’ and is judged by the state’s ability to raise the level of manufactured exports and for coordinating technological upgrading. 

Weiss makes a few recommendations for governments. Firstly, governments should build their ability extract vital information from companies and particular businesses. Secondly, stimulate private sector participation in policy formulation, rather than lobbying. Thirdly, mobilise industry collaboration around a national economic strategy.

Weiss argues that strong government economic policy is determined by, firstly, the sophistication of the bureaucracy; and secondly, the relationship between the state and industry groups. It is important for the bureaucracy to have a sophisticated information-gathering function. Governments should insist upon regular reporting by industry, and particular firms, of the latest production information. It should have a sophisticated analytical ability to predict changes in overall trends and locate problems within specific industries and possibilities for new investment.

Weiss argues that there are two main approaches. The first is transformative or developmental, and the second is distributive. Transformative and distributive states represent divergent strategies for managing economic and industrial change. They are both divergences from free-market modes of economic management.

The primary focus of a country pursuing a transformative strategy to managing the economy is production (supply-side economics). Many of the countries of East Asia fit into this category. The government aims to manage problems of production, and directly facilitates the development of industry in a variety of ways.

Firstly, it can encourage complementary investment decisions. Secondly, it can help organise the specialisation and cooperation of smaller firms. Thirdly, it can promote the sharing of information and technological acquisition, especially within individual industries. Fourthly, it can help socialise investment risk (and facilitating priority access to finance for industry, as in the German model). Fifthly, the state can facilitate long-term investment and very large investments and coordinate investment that needs to be made concurrently. Finally, it can encourage cooperation between primary, secondary and tertiary producers, and across the general economy, for example by encouraging national specialisations.

In contrast, countries that pursue a distributive strategy to managing the economy tend to focus more on socializing the costs of change to the community. According to Weiss, the distributive strategy is a ‘less direct’ form of managing industrial change, and she broadly associates this with Sweden. The distributive model tends to focus more on demand management, and demand-side policies to encourage or indirectly pressure business to engage in industrial transformation. She also argues that some countries combine transformative and distributive capacities, such as in Germany and Austria.

Whereas Dr Dexter will often argue that government should provide subsidies or incentives, Weiss argues that these should not be offered to companies unless there is a commitment that they will also contribute to cost-saving and productivity, rather than their simply becoming rent-seekers. There are various measures available to governments that should be used to create a disciplined industry environment which can foster technological growth. In return for any form of government support or coordination, governments should always make demands on business, including getting results and setting quotas, but also by demanding compliance with any number of other democratically determined initiatives.

Of central importance is that this cooperative relationship is extensive, regularized and institutionalised. Highly skilled bureaucrats need to be well informed of the latest production and investment data. Weiss argues that the institutionalisation of cooperation allows conflict to be managed, rather than becoming an obstacle to national economic development.

According to Weiss, governments should consciously foster the development of united, strong, competent industry associations. If such associations do not exist, the state should develop them. This will facilitate better communication with the government, but also better cooperation, especially within individual industries and between producers at different stages in the production cycle. Also, if the associations are strong they will have the ability to better ensure the compliance of individual businesses and develop a type of ‘forced’ cooperation and consultation between the government and all relevant businesses. Governments should also encourage cooperation between producer groups on their own (private-sector governance).

Weiss argues that globalisation means that the government is now more important to economic development. Globalisation has not forced convergence upon a free-market model across different countries.

Weiss presents evidence to suggest that the expansion of markets, not cost-reduction, is the main reason behind the internationalisation of investment. Multinational corporations do not only invest where wages and taxes are lowest, although we hear many examples of this in the media. Most economic integration is based on a growing ‘regionalisation’ rather than ‘globalisation’ as such. Finally, multinational corporations still maintain a ‘home base’ in one particular country or within one specific region. This obviously has important implications for the governability of capital. For example, a Japanese company is most likely to expand in nearby countries. Therefore, the growth of regional governance organizations, deliberately developed by particular governments, means that these international capitals are not really footloose.

Globalisation does not contribute to the diminishing of the government’s role in the economy. Firstly, Weiss argues that this is only a polemical, rhetorical argument deployed by Dr Dexters to better sell unpopular free-market policies to voters. Also, other political forces pressing for free-market policies contribute.

Weiss argues that there are good reasons why governments might want to encourage the internationalization of domestic investment. Domestic markets are only so big, and therefore there are limits to the amount of profit that can be earned from them. This tendency means that as big companies expand they increasingly need to look to international markets to expand profits and grow their business. This is not necessarily an easy task, and thus the state has a very prominent role in facilitating the process, both in foreign or trade policy terms, but also in assisting with investment and relocation costs. Weiss argues that ‘state capacity is a condition of successful internationalization.’ This has important implications for divergence in the international economy, because if capital cannot easily relocate and participate in new markets in order to pursue profits, it is encouraged to pursue cost-cutting strategies.

Thirdly, Weiss argues that the ‘catalytic state’ has emerged. This is a type of state which is proactive in developing its increasingly complex capacities. It seeks to adapt to new economic challenges by strengthening its cooperative relationships with industry. This type of state is on the front foot in managing technological upgrading and encouraging microeconomic cooperation.

Weiss argues that the existence of global capital is a myth. Capital still maintains a national base and at best mostly only expands throughout its given local region. This obviously has implications for the governability of capital. Weiss maintains that there are several advantages of a national or regional base. Firstly, new technologies become important fixed costs that cannot be shifted easily. Secondly, new production methods support the growth of local producer networks within close physical proximity (especially with non-assembly operations). Finally, the support relationships between national governments and labour groups are an important source of competitiveness. Thus, the advantages of capital mobility can be overstated.

To summarise, Weiss argues that the pressure to globalise arises from a real need for business to expand its opportunities beyond domestic markets. This does not necessarily mean that levels of domestic investment will be lower. The state has an important function to play in this process, and even the governments of relatively weak liberal market countries that concentrate on foreign or trade policy have some important capabilities. Globalisation pressures are just another form of challenge, like so many others that the state has had to respond to, such as stagflation.

Weiss argues that governments can respond to the challenges posed by the globalising world economy and the limits of uncoordinated economies. The type of response is based on how well-developed the government’s capacity is. She argues that the state certainly is an important element in the determination of overall economic conditions and national economic success. This is increasingly the case as economies become more complex, and as economic actors look to transcend the limits of atomised, uncoordinated, uncontrolled economic anarchy.

 

 

 

Key points: ·        There is an alternative to free-market solutions for every problem, but it is not well understood. ·        The New Zealand government’s free-market policy failures contrast with the Singapore government’s policies to promote a high savings rate and develop exports. They are clear examples of what to do, and what not to do. ·        Economic theories have an influence over almost every area of government policy, and are therefore very powerful. ·        Unlike the private sector, governments don’t exist for the purposes of making a profit, but they do provide services and infrastructure that increase the overall efficiency of the economy. Therefore, their costs should not be considered narrowly or in isolation from their benefits.

Possible reforms: ·        Journalists, bureaucrats, politicians and everybody should take the time to be better informed about alternative economic policies. ·        Australia should engage experts from Singapore and other countries, to make suggestions to improve our economic policies. ·        Economists should undertake more empirical and comparative economic policy research. Governments should reduce the level of research funding available to economists for research that isn’t empirical.