Populist revolt around the world making economists rethink

It’s often said that the failure of conventional economics revealed by the global financial crisis has prompted no serious effort to find a new economic theory that actually works. Look closer, however, and you see economists stirring themselves to lift their game.

That’s the view of a noted American economist and critic of his profession, Professor Dani Rodrik, of Harvard, in an article published this week by Project Syndicate.

Rodrik says the populist backlash sweeping the advanced economies in recent years – think Trump, Brexit and Pauline Hanson – has produced some soul searching in the discipline. It is, after all, a backlash against the austerity policies, free-trade deals, financial deregulation and labour market deregulation that economists urged on the politicians (and only in retrospect realised how naive they’d been and how misused by pollies with other agendas).

In consequence of this rethink, “the economics profession is gradually changing for the better”, according to Rodrik. But the transformation extends beyond thinking about economic policy.

Within the discipline there’s finally a reckoning with the hierarchical practices (reverence for seniority and high-status universities) and the macho seminar culture (where anyone who says something silly or unorthodox is brutally shot down) that have produced an inhospitable environment for women and minorities.

According to a survey of its members conducted last year by the American Economic Association, nearly half of female economists felt discriminated against or treated unfairly on account of their gender. Nearly a third of non-white economists felt they’d been treated unfairly because of their ethnicity.

Rodrik, an Egyptian American, thinks the bad policy advice and the inhospitality towards anyone not an old white male may be related. “A profession that is less diverse and less open to different identities is more likely to exhibit groupthink and hubris,” he says.

“If it is to generate ideas to help society achieve inclusive prosperity [and so not push outsiders into the arms of populist politicians with no real answers to the problems being reacted against] it will have to start by becoming more inclusive itself.”

The new face of the discipline was on display at its annual meeting in San Diego early this month. The sessions that attracted the greatest attention were the more than a dozen focusing on gender and diversity.

Also discussed was a new book by the Nobel laureate Angus Deaton and Anne Case, Deaths of Despair. Their research shows how a particular set of economic ideas privileging the supposed “free market”, along with an obsession with material indicators such as aggregate productivity and gross domestic product, have fuelled an epidemic of suicide, drug overdose and alcoholism among America’s (often jobless) working class.

Capitalism is no longer delivering for these people (many of whom switched their votes to get Trump over the line) and economics is, at the very least, complicit, Rodrik observes.

In a panel session at the annual meeting that Rodrik helped organise, Economics for Inclusive Prosperity (note that buzzword inclusive), several new strands of thinking were discussed that are, he claims, “taking over the discipline”.

One was the need to expand economists’ focus from average levels of prosperity (which often look okay) to the distribution of that increased income between top, middle and bottom (which often doesn’t).

Another strand of thought was the non-economic dimensions that are equally fundamental to wellbeing – such as dignity, autonomy, health and political rights – damage to which economists have tended to ignore.

“How economists talk about, say, trade agreements or deregulation may well change when they take such additional considerations seriously,” he says.

“This will require new economic indicators. One proposal that goes part of the way is for government agencies to produce distributional national accounts [something our Australian Bureau of Statistics has been working on].”

Mainstream economists have long claimed their theories and models to be “value-free”. This is self-delusion on a grand scale. In a paper presented to the panel session by Professor Samuel Bowles, of the Santa Fe Institute, and Professor Wendy Carlin, of University College, London, they boldly stated the bleeding obvious.

They argued that every policy paradigm has embedded within it not just a theory about how the economy works, but also a set of ethical values about what the good life entails. Neo-liberalism, for instance, presumes individualistic, amoral individuals and a free market that delivers efficiency, thanks to “complete contracts” (those that leave the other party no room to cheat you, but such contracts don’t exist) and few instances of “market failure” (where, for various reasons, the market fails to work the way the theory says it will).

Clearly, such assumptions go a long way towards explaining why economists failed to foresee that deregulation of the financial system and permissive supervision of it would lead eventually to collapse and deep recession.

Bowles and Carlin said what we needed was a new theory that integrates egalitarian, democratic and sustainability “norms” of acceptable behaviour (the ethical side) with a model of the economy as is really operates today (that is, which would incorporate the insights of behavioural economics).

Such a paradigm would place the community alongside the economists’ conventional dichotomy between the market and the government. And it would include policies such as wealth taxes, broader access to insurance to reduce people’s exposure to risks, workplace rights, reform of corporate governance (none of the convenient fiction that shareholders’ rights trump all others), and a substantial weakening of intellectual property rights (which have devolved from a device to encourage innovation to a prime source of big business rent-seeking).

Professor Luigi Zingales, of Chicago University’s business school, criticised economists for foisting their own preferences on the public. They tended to place greater value on certain outcomes (such as economic efficiency) rather than others (such as the distribution of income) and they fall prey to groupthink and to fetishising particular economic models over others.

I can’t say I’m convinced a revolution in economists’ thinking is imminent, but it’s a start.

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Is Morrison the man who killed the Aussie summer?

This is the summer from hell. I can’t imagine anyone is enjoying their break – not with the quadruple whammy of drought, heatwaves, bushfires and smoke haze we’re experiencing. If it happens again next summer – or the one after – as it very well could, can you imagine the political doghouse Scott Morrison and his Coalition parties will be in?

Morrison is already bearing most of the ire of people displaced by the fires. So much so that he’s learned not to show up to offer his commiserations. But is it really his fault? No. Just one of the six prime ministers we’ve had over the past two decades can hardly take all the blame.

In any case, Morrison is right to protest that nothing Australia could have done by itself could have stopped the deterioration in climate we’re seeing. The only solution is global, so all the big, rich economies – particularly the Americans, less so the Europeans – must share the blame for the continuing rise in average temperatures.

And even the biggest developing economies – China and India, particularly – could have done more to reduce the intensity of their emissions (emissions per dollar of GDP) without abandoning their efforts to raise their living standards to some higher fraction of those we have long enjoyed.

But Morrison doesn’t escape the responsibility of leadership as easily as that. For one thing, it’s his side of politics that’s done most to sabotage the limited and belated efforts Australia has made, since the defeat of the Howard government, to contribute to the global effort to reduce greenhouse gas emissions.

And you have to go back to John Howard’s refusal to ratify the Kyoto agreement of 1997 to find an instance of Australia actively disrupting efforts to reach international agreement on stronger action, to match the shamefully destructive contribution Angus Taylor made at the conference in Madrid last month by insisting that Australia be allowed to use an accounting trick to shirk its responsibilities.

For any Australian leader to claim, hand-on-heart, to have done all they reasonably could to reduce global warming, they have to be able to say they committed us to a disproportionate reduction in our emissions, so as to have the moral authority to press the bigger players to do more. None of our leaders can say that, least of all Howard and Morrison.

And then there’s the law of politics that says if it's fair enough for the government of the day to claim the credit when things go well – even when the seeds of that success were sown by an earlier administration – it’s equally fair for the government of the day to cop the blame when the neglect of earlier administrations finally hits the fan, as it has this summer.

Not Morrison nor any of his predecessors can honestly claim to have been caught unawares by what’s happening before our eyes and noses. The CSIRO has been warning for at least a decade of just this concurrence of adverse and costly events – in lives and health, as well as property – as the planet warms.

At last year’s election, the climate change deniers demanded to be told the economic cost of stepping up our contribution to reducing global warming. The more sensible among us should have been demanding to be told the economic cost of allowing global warming to roll on. We’re finding that out as we speak, but doing so the hard way.

It’s tempting to wonder whether, in his heart of hearts, Morrison is himself a climate-change denier. But that hardly matters. These days, what politicians truly believe doesn’t have much bearing on what they do and say. Conviction politics is dead. These days, politicians seek out the position that, while sitting easily with their heartland supporters, is likely to give them the greatest short-term advantage over their political opponents.

Whatever he believes, Morrison is too cagey to come out as a denier. Like Malcolm Turnbull before him, he’s bound hand-and-foot by the deniers in his own party and the Nationals. So, until now, his safest position has been to say he accepts the science, while falsely claiming to be comfortably on target to reach the (inadequate) emissions reduction we committed to in the Paris agreement.

There are two approaches to the “wicked” problem of global warming: mitigation (reducing emissions) and adaptation (changing in response to whatever warming we get). The greenies have seen these as in conflict and frowned on efforts to adapt. But Morrison and his predecessors have been so bound up by their deniers that they haven’t wanted to talk about even such issues as getting set to cope with much worse bushfire seasons. No excuses for that, Scott.

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how we caught the economic growth bug, but may shake it off

Do you realise that the great god of mammon, Gross Domestic Product, has really only been worshipped in Australia for 60 years last month? Its high priests at the Australian Bureau of Statistics have been celebrating the anniversary.

Sixty years may see a long time to you, but not to me. And not when you remember that the study of economics, in its recognisable form, started with the publication of Adam Smith’s Wealth of Nations in 1776.

GDP is the most closely watched bottom line of the "national accounts" for the Australian economy.

So what do GDP and the national accounts measure, where did they come from and are they as all-important as our economists, business people and politicians seem to think, or is GDP the source of our problems, as many environmentalists and sociologists seem to think?

What GDP measures can be described in several ways. I usually say it measures the value of all the goods and services produced in Australia during a period.

But because workers and businesses join together to produce goods and services in order to earn income, it’s equally true to say that GDP is a measure of the nation’s income during a period.

And since income is used to buy things, it’s also true that GDP measures the nation’s expenditure (but only after you subtract our spending on imports and add foreigners’ spending on our exports).

Now some qualifications.

GDP measures the value of goods and services bought and sold in the market place, plus the goods and services supplied by governments but paid for by our taxes. This means GDP doesn’t include the (considerable) value of all the goods and services – meals and so forth – produced in the home without money changing hands.

Economists (and economic journalists) make so much fuss about the quarterly ups and downs of GDP – is the economy growing or contracting, is it growing faster or slower? – it’s easy to assume that economic growth is something they’ve always obsessed about.

In truth, it’s a relatively recent preoccupation – suggesting it’s a habit we may one day grow out of. You see this more clearly when you consider the origins of GDP and the national accounts it springs from.

The 60-year anniversary is of the move to quarterly estimates of the growth in GDP in September quarter, 1959. It’s hard to be obsessive about something when you don’t get regular reports on how it’s going.

Fact is, until the Great Depression of the 1930s, economists were preoccupied with studying how markets worked ("micro-economics") and gave little thought to how the economy as a whole worked ("macro-economics"), let alone how fast it was growing.

In his recent history of the federal Treasury, Paul Tilley noted that it was just a department full of bookkeepers until the upheavals of the Depression caused its political masters to ask questions about what they should be doing that it couldn’t answer. That’s when Treasury became macro-economists.

It was the failure of "neo-classical" economics to provide an effective response to the Depression that led to the ascendancy of an Englishman who did have answers, John Maynard Keynes. At the heart of the ensuing the "Keynesian revolution" in economics was the notion that there was such a thing as the macro economy and that it was the responsibility of governments to "manage" that economy, ending its slump and getting workers back to work.

Once you started thinking like that, it became obvious that, to manage the economy effectively, you needed to measure it and track the changes in it over time.

The first economists to start developing a systematic and internally consistent way of measuring the economy, in the early 1930s, were Simon Kuznets in the United States and Colin Clark in Britain. Clark, a disciple of Keynes, moved to Australia in 1938 and spent the rest of his life as an adviser to the Queensland government.

For some years after World War II, our Treasury issued annual, out-of-date estimates of the size of GDP and its components.

The Keynesian economists’ preoccupation then was not with growth as such, but with keeping the economy at "full employment" – in those days defined an unemployment rate of less than 2 per cent – which, admittedly, did require it to be growing pretty quickly. In those days, however, GDP was used more as an aid to the short-run stabilisation of the business cycle – "demand management".

Paul Samuelson’s legendary introductory textbook, first published in 1947, which "brought Keynesian economics into the classroom", didn’t have an entry for "growth" until its sixth edition in 1964.

It was only about then that people became preoccupied with economic growth, as indicated by the growth in GDP.

The critics are right to point out the many respects in which GDP falls short as a measure of human wellbeing. But, though it’s true many people treat GDP as though it is such a measure, it was never designed to be used as such.

I agree with the critics that there’s more to life than economic growth and that politicians and economists should give less attention to growth and more to the many less tangible, less well-measured social factors that also affect our wellbeing.

It’s true, too, that GDP was developed before we became conscious of the need for economic activity to be ecologically sustainable – which the present hellish summer reminds us it certainly isn’t at present. In this sense, GDP is no longer "fit for purpose".

It’s wrong, however, to conclude that continuing growth in GDP is incompatible with ecological sustainability. People say that because they don’t understand what drives the "growth" that GDP measures (hint: improved productivity).

We can have unending growth in GDP and sustainable use of natural resources (which is what the environmentalists care about) by changing the way economic activity is organised – including by getting all our energy from renewable sources.

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Government on the cheap leaves us burningly reliant on charity

As the cast were taking their bows at the end of a show before Christmas, one of them stepped forward to say that, as we left, we’d be approached by people with buckets collecting for the NSW Rural Fire Service. Normally I’d reach for my wallet – I’d done so a few weeks earlier when they were collecting for an actors’ charity – but this time I declined.

Like Victoria’s Country Fire Authority, the RFS is staffed by volunteers. Why did they need donations? Presumably, to help cover the cost of needed equipment or incidental expenses. Really? What’s happened to the state government’s cheque book? And don’t I remember hearing that the RFS had had its funding cut?

No one believes every worthy cause should be funded by the government so that private charity becomes redundant. And it’s true the federal government partially subsidises donations by making them tax-deductible. But where do you draw the line between what the government should cover and what can be left to the generosity – or otherwise – of private citizens?

The more I think about it, the more I realise that, as part of their commitment to Smaller Government and lower taxes, governments have been quietly shifting the dividing line between what the government pays for and what should depend on charity.

All governments have been doing it. State governments, for instance, have long left country (but not city) fire-fighting to volunteers. And have long underfunded the upkeep of public schools, believing parents and citizens can be left to make up the shortfall. But it’s been a particular trick of the federal Coalition government as it struggles to return its budget to surplus when there are expensive, vote-buying tax cuts to be covered.

If you’re wondering why, despite his contrition at having taken an overseas break his spin doctors tried to keep secret, and his freely dispensed “thoughts and prayers”, Scott Morrison remained adamant for so long that all that was needed was already being done to help the firefighters, it’s because he knows that too much generosity on the feds’ part could see his precious budget surplus whittled down to nothingness.

Since its election in 2013, this government has been insistent that the budget should be returned to surplus by cutting government spending, not by explicit increases in taxes (hidden tax increases caused by bracket creep are okay, of course, because the punters don’t notice ’em).

Its first budget in 2014 was a long-term plan to improve the budget by what the bureaucrats call “cost-shifting”. Much of the cost of health and education was to be shifted onto the states’ budgets. Some was to be moved to your household’s budget via the $7 charge for visits to the doctor.

That budget was so badly received most of those plans were reversed. But Finance Minister Mathias Cormann and his accountants have continued to limit the growth in government spending by penny-pinching in ways that voters wouldn’t notice or object to.

They’ve got welfare dependency to “its lowest level in 30 years” not by getting the unemployed into jobs, but by using petty excuses to suspend people’s dole payments. How do these unfortunates live without money to live on? They fall back on their families or go cap-in-hand to the Salvos or Vinnies. Get it? The feds are cost-shifting to charities – the same community groups whose grants they’ve cut back.

According to a recent survey of its members’ staffs by the Australian Council of Social Service, 76 per cent of staff dealing with housing the homeless reported an increase in demand, as did 71 per cent of those providing financial counselling and support (aka money). Respondents to the survey said the unmet demand naturally had adverse impacts on the community. Where people fall through the cracks they can end up in hospitals or the justice system (cost-shifting to the states).

I’ve been reading about how many small country towns are relying on newly formed charities for their supply of water. More broadly, the desire to limit government spending encourages politicians to ignore reports warning of looming troubles and push problems off into the future. Some of the foreseen problems fail to materialise, but many eventually reach crisis point and can no longer be ignored.

The aged care royal commission is revealing the shocking results of one attempt to keep government small by relying on for-profit providers, underspending on the provision of home-care packages and on policing institutions’ adherence to the rules.

Which brings us back to our truly heroic volunteer firefighters. Morrison’s reluctant decision to pay them $300 a day for a maximum of 20 days is the least he can do to acknowledge their loss of income (or annual leave) while serving their communities.

His reluctance – and anxiety to emphasise it’s not a payment of wages – is understandable, however. Behavioural economics is clear that paying people to do what they formerly did without payment can kill the motivation to donate your services for noble reasons. Morrison has stressed that this response to a problem of unprecedented severity shouldn’t be seen as setting a precedent.

Good luck with that. If climate change is making drought, heatwaves and bushfires bigger and more frequent, the horrific events of this summer will become a regular occurrence – meaning the days of leaving bushfire fighting to unpaid volunteers are numbered.

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Living in the post-inflation era turns out to be no fun

It’s Christmas shopping time, when the bills mount up and your money never goes far enough. So how come people are saying the inflation rate should be higher? I thought inflation was meant to be a bad thing?

It’s a good question when one of those people is Reserve Bank governor Dr Philip Lowe. He keeps saying we need to get unemployment lower and inflation back up into the 2 to 3 per cent target range. (At last count the annual rate of increase in consumer prices was "only" 1.7 per cent. I can remember when, for a brief period in the 1970s, it was 17 per cent.)

The short answer is that Lowe doesn’t see higher prices as a good thing in themselves. Rather, he sees them as a means to an end. Or better, as a symptom or by-product of something that is a good thing.

Why do prices rise? Because the demand for goods and services – the desire to purchase them – is growing faster than the supply of them – our businesses’ ability to produce them. So the rate of price inflation is a symptom or sign of strong demand.

And strong demand for goods and services is a good thing because it means the economy is growing and so is employers’ need for workers to help produce more goods and services. Employment increases and unemployment falls.

So Lowe wants to see higher prices simply because they’re a means to the end of lower unemployment. What’s more, increased employer demand for labour relative to its supply makes labour – particularly skilled labour – scarcer and so puts upward pressure on its price, otherwise known as wages.

And, as he’s often said, Lowe would like to see employers paying higher wages than they are, because consumer spending – consumer demand – is so weak at present mainly because wages are hardly growing faster than consumer prices, and real wages are the main thing that drives consumer spending.

All that make sense? Good – because now I’ll give you the more complicated answer. Surely, although strong demand is good for the economy, it would be better if supply was just as strong, meaning we could have growth in jobs and living standards without any inflation?

That makes sense in principle, but not in practice. The managers of the macro economy believe we need some inflation, though not too much. For two reasons. First, though you’ll find this hard to credit, economists are sure our consumer price index (like other countries’ CPIs) overstates inflation.

That’s because the official statisticians are unable to pick up all the cases where prices rise not simply because the firm’s costs have risen, but because the quality of the product has been improved. If so, aiming for a measured inflation rate of zero would require you to crunch the economy hard enough to make actual inflation less than zero – that is, prices would be falling.

The second reason is that sometimes, when the economy is growing too strongly, wages rise too much, prompting firms to lay off workers. Trouble is, workers hate having their wages cut. But if you’ve got a bit of inflation in the system, you can cut wages in real terms simply by skipping an annual pay rise, which workers find less unpalatable.

When the Reserve Bank set its target for inflation in the early 1990s, it settled on 2 to 3 per cent a year ("on average over the medium term"). It thought such a range would overcome both problems and insisted such a target range constituted "practical price stability".

But things in our economy and all the advanced economies have changed a lot since the 1990s. Demand has been chronically weak relative to supply since the global financial crisis and, in consequence, inflation rates have been below-target everywhere.

Some people have suggested we move to a lower, more realistic target range, but Lowe has resisted, arguing that to do so would lower firms’ and workers’ expectations about inflation, making our weak-demand problem even worse. He may be right.

But now try this thought. Inflation is 1.7 per a year, while wages are growing by 2.2 per cent and workers aren’t at all happy. I’ve had several top economists agree with my contention that, if we could wave a magic wand and raise both inflation and wages by, say, 2 percentage points, so that wages were growing by 4.2 per cent, workers would be a lot less discontented.

Why? Because of a phenomenon that economists used to talk about a lot in in the 1960s, but rarely mention today, called "money illusion". People who aren’t economists keep forgetting to allow for inflation. If so, the era of very low inflation isn’t proving to be much fun.

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