Monday, February 2, 2015

Economists shouldn’t be apologists for business

As the nation's economists gird their loins for a year of furious debate over economic management and reform, there's a soul-searching question they need to face.

This year's policy agenda will be dominated by economic issues. First is what's to be done about what wasn't done last year: the failure to get the budget on a credible course towards eliminating the structural deficit.

What can be done to reduce wastefulness in health spending that makes more sense than GP co-payments? Is it really a smart idea to partially deregulate government-owned and highly bureaucratic universities with their high degree of pricing power?

Apart from the government's response to last year's review of the financial system, there's the various inquiries being conducted this year: the review of the tax system, review of federal-state responsibilities and review of industrial relations.

In these things the government's big-business backers have very strong views about which reforms it should take for ratification at next year's federal election.

But while the economists are willing the politicians to "show leadership" there's a tough question they should be asking themselves: is conventional economics in reality just a rationalisation of the interests of business? Are economists spin doctors seeking to advance the greed of the rich and powerful?

That's certainly not what economics is supposed to be about. Its stated ethic is that the interests of consumers should always trump those of producers. Adam Smith's Wealth of Nations carries a powerful condemnation of business people's propensity to engage in rent-seeking.

But that's just the theory. In practice these days, it's hard to find many economists pushing such a line in the public debate. One honourable exception is Professor Ross Garnaut, who has pointed to the way the push for economic reform has degenerated into rival interest groups striving for nothing more than sectional advantage.

Why are so few of his colleagues joining him in this cause? Why do so many economists stay silent while business interests distort the principles of economics to disguise their self-seeking? And, indeed, many economic consultants make their living by crafting such distortions - often through modelling - for whoever can afford their services.

One reason for the economists' silence is that most are employed by bosses who don't want them criticising business. The business economists may speak endlessly on whether or not the Reserve Bank will cut interest rates, but on little of lasting importance. Econocrats aren't supposed to express personal opinions and, in any case, their masters - of either colour - wouldn't want them offending business.

Even the academic economists enjoy less freedom to critique business behaviour in an era where the backdoor privatisation of universities has made them more dependent on business donors and where individuals are too busy publishing or perishing in journals with zero interest in Australian issues.

But the full explanation goes far deeper. Biases hidden in the neo-classical model of how markets work have caused "the economists' way of thinking" to be deeply suspicious of government intervention in markets and unthinkingly supportive of business behaviour.

One bias is the assumption that economic agents always behave rationally in pursuit of their self-interest. So individuals always know better than governments and any strange behaviour by businesses can be explained only by their rational response to distortions caused by interfering politicians.

Another bias arises from the model's unit of analysis: the individual firm or consumer. This leaves no room in the model for any kind of benefit from collective action. Rather, the market's "invisible hand" transforms agents' rational self-interest into the public good.

So economists keep mum while governments assume the budget can be returned to surplus only by reducing government spending, not by increasing taxation, and that all government spending is dubious, but distorting "tax expenditures" (which, purely by chance, heavily favour business and high income-earners) aren't a problem.

Even so, many economists are inclined to agree with business lobbies that the one exception to the fatwa against higher taxes could be an increase in the goods and services tax - provided the extra revenue is used to reduce the tax on companies or high income-earners.

As for industrial relations, conventional economic theory's primitive analysis of the labour market - which largely assumes away differences in the quality of labour, as well as assuming units of labour are no different from units of any commodity - leaves many economists happy to accept that the more bargaining power employers enjoy the better off all of us will be.

Many of these ingrained prejudices are being challenged by empirical research, but "evidence-based policy" that doesn't fit with business's perceived interests is being studiously ignored by most economists.