Steve,
At 08:59 30/10/2009 -0400, you wrote:
Damn good overview.
Cleverly written but hardly a fair review of Adam Smith's real views on the
need for a great deal of redistribution. Here is something from one of the
most reputable historians on this matter:
"Even though Adam Smith is best known for arguing in favour of free
markets, he saw a case for having taxes and public spending provide useful
things that individuals could not provide adequately for themselves.
National defense, justice, commercial infrastructure, and public education
should be funded by taxes, or even directly provided as state services. The
case arises from the same basic point, both in The Wealth of Nations and in
today's economics: If individuals fail to capture all the social gains from
providing these things, then individuals could not be relied upon to
provide enough of them." (Peter H. Lindert Growing Public CUP 2004)
Keith
Steve
<http://thearchdruidreport.blogspot.com/2009/10/why-markets-fail.html>http://thearchdruidreport.blogspot.com/2009/10/why-markets-fail.html
WEDNESDAY, OCTOBER 28, 2009
<http://thearchdruidreport.blogspot.com/2009/10/why-markets-fail.html>Why
Markets Fail
Its a safe bet that any public comment on the politics of peak oil, unless
it sticks closely to one of a very few widely accepted opinions, will
provide a good demonstration of the laws of thermodynamics by turning
plenty of energy into waste heat. Last weeks Archdruid Report post was no
exception. Between those who thought I was too hard on Cuba, those who
thought I was too soft on Cuba, those who insisted America is already a
fascist dictatorship, those who thought America would be better off as a
fascist dictatorship, and a variety of less classifiable rants, I was well
and truly denounced. My favorite for the week was a bit of online splutter
that, having exhausted its authors apparently limited vocabulary of
profanity, wound up with the nastiest term he knew: ...you American!
Those of my readers with a taste for wry humor may well have found all
this as entertaining as I did. Still, this weeks essay will leave such
amusements behind, and return to the theme Ive been developing in recent
posts, the reinvention of economics that will be necessary in an age of
hard ecological limits and deindustrial decline. Vegetarians and animal
rights activists take note: a certain number of sacred cows will have to
be slaughtered and dissected in the course of that inquiry, and the
process is unlikely to be either painless or clean.
Of the sanctified cattle facing a gruesome fate in the years ahead of us,
perhaps the most important is that blue-ribbon heifer of modern economics,
the belief in the infallibility of free markets. Back in 1776, Adam Smiths
The Wealth of Nations popularized the idea that free market exchanges
offered a more efficient way of managing economic activity than custom or
government regulation. The popularity of his arguments has waxed and waned
over the years; it may come as no surprise that periods of general
prosperity have seen the markets alleged wisdom proclaimed to the skies,
while periods of contraction have had the reverse effect.
The economic orthodoxy that has been welded in place in the western world
since the 1950s, neoclassical economics, made a nuanced version of Smiths
theory central to its theories, arguing that aside from certain exceptions
much discussed in the technical literature, people making rational
decisions to maximize benefits to themselves will simultaneously maximize
the benefits to everyone. The neoclassical synthesis has its virtues; you
wont find neoclassical economists claiming, as the free market
fundamentalists of the Austrian school so often do, that the market is
always right, even when its vagaries cause catastrophic human suffering.
The concept of market failure is part of the neoclassical vocabulary, and
some useful work has been done under the neoclassical umbrella to explain
how it is that markets can fail to respond to crucial human needs, as they
routinely do.
Still, the great problem with neoclassical economics is the one has
already been discussed in these posts: its models have consistently failed
to foresee devastating economic disasters that many people outside the
economics profession could readily and accurately predict years in
advance. The implosion of the world economy in 2008 is only the most
recent case in point. One writer who surveyed the economics field in the
aftermath of the crash noted with some asperity that fewer than two dozen
economists anywhere in the world warned in advance of the gargantuan
bubble of securitized debt that exploded that year.
On the contrary, economists by the score lined up during the bubble years
to insist that the giddy financial innovations of the previous decade had
banished risk from the market and prosperity was assured into the
foreseeable future. They were of course quite wrong, and their failure to
see disaster as it loomed up in front of them compares very poorly with
the large number of people who used historical parallels to recognize what
was happening and make uncomfortably precise forecasts of the results.
(Keith Brand, who ran the lively HousingPanic blog straight through the
bubble, memorably summarized those predictions: Dear God, this is going to
end so badly.)
I have discussed in several earlier posts some of the reasons why the
entire economics profession has been so prone to miss the obvious in such
cases. Here, though, I want to focus on a reason for failure thats
specific to neoclassical economics. Since most of the economists who
provide advice to governments come out of the neoclassical mainstream,
this is hardly irrelevant to our prospects for the future, especially as I
intend to show because the same blind spot that left so many pundits
dining on a banquet of crow in recent months applies with even greater
force to the crucial fact of our time, the arrival of peak oil.
The point I want to make here is a little different from the most common
critique of neoclassical economics, though there is a connection. Many
social critics have commented on the ease with which the neoclassical
synthesis consistently ignores the interface between economic wealth and
power. Even when people rationally seek to maximize benefits to
themselves, after all, their options for doing so are very often tightly
constrained by economic systems that have been manipulated to maximize the
benefits going to someone else.
This is a pervasive problem in most human societies, and its worth noting
that those societies that survive over the long term tend to be the ones
that work out ways to keep too much wealth from piling up uselessly in the
hands of those with more power than others. This is why hunter-gatherers
have customary rules for sharing out the meat from a large kill, why
chieftains in so many tribal societies maintain their positions of
influence by lavish generosity, and why those nations that got through the
last Great Depression intact did so by imposing sensible checks and
balances on concentrated wealth though most of those checks and balances
in the United States were scrapped several decades ago, with utterly
predictable results.
By neglecting and even arguing against these necessary redistributive
processes, neoclassical economics has helped feed economic disparities,
and these in turn have played a major role in driving cycles of boom and
bust. Its no accident that the most devastating speculative bubbles happen
in places and times when the distribution of wealth is unusually lopsided,
as it was in America, for example, in the 1920s and the period from 1990
to 2008. The connection here is simple: when wealth is widely distributed,
more of it circulates in the productive economy of wages and consumer
purchases; when wealth is concentrated in the hands of a few, more of it
moves into the investment economy where the well-to-do keep their wealth,
and a buildup of capital in the investment economy is one of the necessary
preconditions for a speculative binge.
More broadly, concentrations of wealth can be cashed in for political
influence, and political influence can be used to limit the economic
choices available to others. Individuals can and do rationally choose to
maximize the benefits available to them by exercising influence in this
way, but the results can impose destructive inefficiencies on the whole
economy. In effect, political manipulation of the economy by the rich for
private gain does an end run around normal economic processes by way of
the world of politics; what starts in the economic sphere, as a
concentration of wealth, and ends there, as a distortion of the economic
opportunities available to others, ducks through the political sphere in
between.
A similar end run drives speculative bubbles, although here the
noneconomic sphere involved is that of crowd psychology rather than
politics. Very often, the choices made by participants in a bubble are not
rational decisions that weigh costs against benefits; its not accidental
that the first, and still one of the best, analyses of speculative binges
and panics is titled Extraordinary Popular Delusions and the Madness of
Crowds. Here again, a speculative bubble starts in the economic sphere, as
a buildup of excessive wealth in the hands of investors, which drives the
price of some favored class of assets out of its normal relationship with
the rest of the economy, and it ends in the economic sphere, with the
crater left by the assets in question as their price plunges roughly as
far below the mean as it rose above it, dragging the rest of the economy
with it. Its the middle of the trajectory that passes through a particular
form of crowd psychology, and since this is outside the economic sphere,
neoclassical economics cant deal with it.
This would be no problem if neoclassical economists by and large
recognized these limitations. Unfortunately a great many of them do not,
and the result is the classic type of myopia in which theory trumps
reality. Since neoclassical theory claims that economic decisions are made
by individuals acting freely and rationally to maximize the benefits
accruing to them, its seemingly all too easy for economists to believe
that any economic decision, no matter how harshly constrained by political
power or wildly distorted by the delusional psychology of a bubble in full
roar, must be a free and rational decision that will allow individuals to
maximize their own benefits and benefit society as a whole.
Now of course, as mentioned in an earlier post, those who practice this
sort of purblind thinking often find it very lucrative to do so.
Economists who urged more free trade on the Third World at a time when
free tradedistorted by inequalities of power between nations was beggaring
the Third World, like economists who urged people to buy houses at a time
when houses were preposterously overpriced and facing an imminent price
collapse, not uncommonly prospered by giving such appallingly bad advice.
Still, it seems unreasonable to claim that all economists are motivated by
greed, when the potent force of a fundamentally flawed economic paradigm
also pushes them in the same direction.
That same pressure, with the same financial incentives to back it up, also
drives the equally bad advice so many neoclassical economists are offering
governments and businesses about the future of fossil fuels. The
geological and thermodynamic limits to energy growth, like political power
and the mob psychology of bubbles, lie outside the economic sphere. The
interaction of economic processes with energy resources creates another
end run: extraction of fossil fuels to run the worlds economies, an
economic process, drives the depletion of oil and other fossil fuel
reserves, a noneconomic process, and this promises to flow back into the
economic sphere in the extended downward spiral of contraction and
impoverishment Ive called the Long Descent.
Here again, neoclassical economics is poorly equipped to deal with the
reality of noneconomic constraints on economic processes. It thus comes as
no surprise that when an economist enters the peak oil debate, it is
almost always to claim that there is nothing to worry about, because the
market will solve any shortfall that happens to emerge. As shortfalls
emerge, expect to hear the claim already floated by a few economists that
declining production is simply a sign that the demand for fossil fuel
energy has decreased. No doubt when people are starving in the streets, we
will hear claims that this is simply because the demand for food has dropped.
There are promising signs that the grip of neoclassical theory on modern
economics is beginning to weaken. A recent conference on biophysical
economics a field which embraces the heretical concept that the laws of
nature trump the laws of money attracted many attendees and, in a shift of
nearly seismic proportions, managed to get coverage in the New York Times.
Other alternative viewpoints in economics are beginning to be heard, as
they usually are in times of financial woe. Still, whats needed now is
something even more sweeping: an economics of whole systems, perhaps
modeled on ecology, in which the entire world of noneconomic factors that
influence economic processes is explicitly included in theories and
practical analyses. Until that emerges, the advice governments and
businesses receive from their paid economists may well continue to make
matters worse rather than better.
Posted by John Michael Greer
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