The Economic Debate

In an earlier discussion,  a simplified model was introduced that attempted to outlined some of the basic interactions between a government, its people, its banks and its industry, which collectively might be used to define a national economy. However, as a an introductory precursor to the wider issues to be ‘debated’ in this section of discussions, this earlier model is now updated with some more detail. Of course, even this updated model is only representative of the real structural complexity that exists within most developed nation-states, which are also subject to many variations in the institutions of state and cultural heritage. However, its main purpose is simply to highlight that any economy does not operate in isolation of the rest of society or for that matter other wider global issues.

The model above attempts to be relatively generic in its description, therefore the use of the dollar ($) symbol should only be seen as representative of any currency in circulation. Likewise, while the conceptual breakdown of the government is shown in the general terms of an ‘executive, legislative and judiciary’, the day-to-day running of the state is usually carried out through the bureaucracy of government departments and officials. Equally, although the model may suggest a clear separation of executive, legislative and judiciary in terms of policy, laws and judgments, not all political systems support this separation in terms of any actual autonomy of action. Again, different political systems might also have varying degrees of control over the ‘treasury’ and the ‘central bank’ as government departments, although in many cases the latter may effectively be a private company owned by shareholders. However, in stark contrast to any arms length control of the economy, the ‘military’ encompassing land, sea and air services and an ever growing array of ‘intelligence services’ are usually kept under the close control of the government, irrespective of its political ideology, although plausible denial is still often required by politicians.  As such, we might perceive the ‘government’ along with its control of ‘fiscal policy’ and national and public ‘services’ to represent the top-tier within the structural hierarchy of some nation-state that controls the national economy. Below this top-tier of government control, we might see the devolution of some of the overall control to ‘ local government’ that may have a limited ability to collect local taxes and modify local services, e.g. police and social services, within the constraints of government policy and funding. On the financial side of the model, we might highlight a more indirect form of government control of ‘private banks’ and the ‘finance services’  via the ‘treasury’ and ‘ central bank’ using ‘monetary policy’ to change interest rates and the amount of currency in circulation and ‘fiscal policy’ to change tax rates and the level of government spending.

Note: As a generalization, the central bank reserves may be described in terms of the deposits made by private banks into their accounts with their central bank. Some central banks set a minimum reserve requirement, e.g. 10%, which private banks have to deposit with the central bank to cover their default liabilities and day-to-day transactions with other private banks. However, this type of reserve may only exist as electronic credit on a balance sheet and, as such, may have little intrinsic value in an economic crisis, even if there were figures to quantify the overall amount held by the central bank. Therefore, as a very broad estimate, it is possible that many central banks have less than 10% in gold reserves and 5% in foreign currency in comparison to the public debt of the government.

In many ways, it might be said that central banks use private banks as an intermediary through which the treasury can directly acquire currency on behalf of the government by issuing bond IOUs to finance spending or to inject currency into the economy via the central bank using quantitative easing – see Currency Dynamics for more details. While the components of the economy described in terms of the ‘private banks’ and the ‘financial services’ are often assumed to contribute to the GDP of the nation-state, there is an argument that this contribution should be classed as ‘unearned income’ because it is typically leveraged off the interest earned on debt rather than by the productivity of industry or commerce. In this context, ‘ industry and commerce’ are the primary producers of products that are sold to ‘people’ and all other forms of consumers in society, which might then be equated to ‘ earned income’ . However, it would be naïve to assume that the ‘engine’ of any modern economy could function without the financial ‘lubrication’ provided by private banks and the financial sector, although it is important to recognise the impact that the interest charges on excessive debt, both public and private, can also have a detrimental effect on the economy. Finally, the updated model recognises that ‘people’, ‘industry and commerce’ plus the ‘private banks and financial services’ all contribute to the tax revenue of the government via the treasury.

OK, but what purpose does this model really serve?

In the previous section of discussions entitled Economic Model Dynamicssome attempt was made to outline a number of dynamic mechanisms associated with currency, debt, cyclic and leverage plus how they might contribute to the cycle of boom-bust in most economies. While admitting that these outlines do not present the totality of the actual complexity within an economy,  we also have to question the accuracy of the myriad of sophisticated models that have failed to predict some future outcome of an economy. Of course, almost by definition, all models are simplifications of a far more complex system, which are invariably based on assumptions that may turn out to be flawed. However, while models in theoretical science might continue to be highly speculative due to an ongoing lack of empirical verification, this should not be the case in economics, which can clearly verify the accuracy of any model within the space of a few years plus has a mass of historic data on which to base its initial assumption.

So why have all these economic models been so unreliable?

At this point, we possibly need to return to the idea of the human condition, which may drive some people to conform to the mainstream consensus. The idea of a mainstream consensus has always existed in both religion and science, although history suggests that this consensus will invariably weakened over time as new facts are discovered and then accepted. Of course, there is nothing wrong with going along with the consensus as long as some form of duty of inquiry is undertaken and the mainstream consensus does not attempt to censor alternative viewpoints and arguments.

In economics, all the non-orthodox people can’t get jobs in the main universities because we don’t push the mainstream paradigm. Steve Keen

Of course, the problem implied by the quote above extends beyond just the issue of unemployed economic professors, because the course material that will be taught to the next generation of economists may simply continue to entrench mainstream theory without questioning it. Equally, without the backing of mainstream respectability, the work of many ‘non-orthodox’ academics will invariably fail the criteria of mainstream economists within the process of peer review and therefore limit the distribution of their ideas. While the development of the Internet has now allowed many to publish their work on-line to a wider audience, its validity might still be questioned given the number of conspiracy theories that now flood the Internet every day. With this cautionary note in mind, Paul Krugman published an Internet article back in 2009 entitled ‘How Did Economists Get It So Wrong?’ from which the following extract is taken:

It’s hard to believe now, but not long ago economists were congratulating themselves over the success of their field. Those successes, or so they believed, were both theoretical and practical, leading to a golden era for the profession. On the theoretical side, they thought that they had resolved their internal disputes. Thus, in a 2008 paper titled ‘The State of Macroeconomics’, Olivier Blanchard of MIT and now the chief economist at the IMF, declared that ‘the state of macroeconomics is good’. The battles of yesteryear, he said, were over, and there had been a ‘broad convergence of vision’. And in the real world, economists believed they had things under control: ‘the central problem of depression-prevention has been solved’ declared Robert Lucas of the University of Chicago in his 2003 presidential address to the American Economic Association. In 2004, Ben Bernanke, a former Princeton professor who is now the chairman of the Federal Reserve Board, celebrated the Great Moderation in economic performance over the previous two decades, which he attributed in part to improved economic policy making. Last year, in 2008, everything came apart. Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy.

The scope of this apparent misunderstanding of the underlying economy due to ever-growing debt appears hard to believe, especially when attributed to people charged with the responsibility of guiding the global economy. If we accept that these people were not stupid, or ignored the real facts, is it any wonder that people forward other conspiracy theories to explain the state of economy. However, it is possible that things are changing as students have started to protest that conventional academic courses have failed to explain the problems within the global economy, which is now forcing many universities to revise their economics curriculum. Following the 2008 financial crisis and the apparent failure to formulated an effective recovery, student groups have also started to criticise the scope of the economic agenda for not addressing the world’s pressing social issues, e.g. wealth inequality. This grassroots protest of the next generation of economists has now won the backing of prominent economists such as Joseph Stiglitz, a winner of the Nobel Memorial Prize in Economic Sciences in 2001 and former chief economist of the World Bank and, in addition, Andy Haldane, chief economist at the Bank of England.

Note: Today, the Internet and Youtube have also allowed ‘non-orthodox’ economists like Michael Hudson, Steve Keen, Mark Blyth , James Rickards and Thomas Piketty to promote their ideas to a much wider audience. Of course, the reader is advised to apply the same ‘duty of inquiry’ to their ideas as with any other from mainstream economics.

Most of the economists highlighted above cite the issue of the high level of debt, both public and private, as a root cause of many of the problems now affecting the global economy. In part, some of the issues surrounding debt were outlined in the discussioncyclic dynamics’ and then discussed further in the discussion leveraging dynamics . While this latter discussion attempted to forward some possible solutions to the debt crisis in the form of debt  write-down, longer repayment periods and lower interest rates, there was some scepticism as to whether the creditors, who generally hold positions of power and influence, would ever agreed to adopt such solutions, even assuming that they would work. However, it is possible that without some form of new economic thinking, the growing level of wealth inequality will not be resolved any time soon, which may then result in increased social unrest causing knock-on instability in global trade.

So what is implied by wider global issues and stability in the model outlined?

Today, few if any nation-states can operate independently of the global assessment of its governance, covering its political, economic and social decisions. Equally, by the same token, decisions of other nation-states, especially powerful ones, within a globalised economy can also have far-reaching implications on many other nation-states. The scope of these implications are simply too numerous to specify in any detail, but a flavour of these issues might be recognised in the following quote from the original Limits to Growth report that could be applied to any modern society:

The limits-to-growth model is a simplification of reality, which does not distinguish among different geographic parts of the world, nor does it represent separately the rich and the poor, there is no military capital or corruption explicitly represented in the model, because incorporating those many distinctions would not necessarily make the model better and very much harder to comprehend. This probably makes the model highly optimistic. It has no military sector to drain capital and resources from the productive economy. It has no wars to kill people, and destroy capital, nor waste lands. It has no ethnic strife, no corruption, no floods, earthquakes, nuclear accidents, or AIDS epidemics. As such, the model represents the uppermost possibilities for the ‘real’ world.

While we might recognise that the model outlined in this discussion is essentially a static representation of the interfaces between the various components that make-up a modern nation-state, it may also help to highlight that any effective economic solution has to consider issues beyond financial modelling. For the outcome of any economic theory can be thwarted by a myriad of social and political issues that can profoundly affect the stability of any economy in unpredictable ways.