Three global crises in the new millennium have revealed flaws in the ruling paradigm of economic policies. The 2008 financial crisis, the 2020 Covid pandemic and now inflation rearing its ugly head across the world.
GDP growth has become an economist’s panacea for systemic economic problems such as persistent poverty and weak government revenues. The way to ensure growth in this paradigm is to get governments out of the way of private enterprise, reduce the sizes and budgets of governments, and allow capital and trade to flow freely across national boundaries. This paradigm of free market economics—the Washington Consensus—seemed to have won the Cold War and according to Francis Fukuyama’s premature declaration in 1991 also ended ideological history.
The 2008 financial crisis revealed structural weaknesses in deregulated economies. A 2008 report by the Commission of Growth and Development, led by Noble Laureate Michael Spence, recommended solutions for increasing global growth. It admitted, however, that while economists could confidently recommend how GDP can be increased, they did not yet know how to make growth inclusive at the same time.
Their models were based on the assumption that macro growth lifts all boats, with accumulating wealth trickling down. However, the trickle down does not happen automatically. In fact, as Thomas Piketty and Oxfam revealed, wealth was flowing upwards, with the “leave it to the market and get governments out of the way” ideology that pervaded economic policies from the 1980s.
The Covid crisis revealed more starkly the flaws in economic models. While billions lost incomes, stock markets boomed and the wealthiest 1% became even wealthier. Central bankers had loosened money supply after the financial crisis to boost economic growth. Then governments increased income support and subsidies during the pandemic, straining government budgets and alarming financial markets. Policy-makers vowed that when the crisis passed, they will not merely build back economies. Economic models will be reformed for more resilient, and more equitable, economic growth.
In the last century, mainstream economics became a secular priesthood driving government policies. The priesthood has its own inner circle. It became heretical to challenge its articles of faith. Since the crises debates have sprung up amongst economists about flaws in their models. The dominant model that drove the Washington Consensus, of minimum government and maximum private enterprise with unrestricted global markets, has been challenged by many eminent economists, that include Joseph Stiglitz and Marianna Mazucatto.
Macro-economic models have been founded on the premise that the economy is a self-regulating machine. In this model, the less governments interfere with it, the smoother it will run. Central banks, independent of governments, must ensure a stable currency for transactions amongst market participants, and then let markets set prices for everything, including wages (which for the majority of people is their only income).
Efficiency, a measure that economists, and managers, value more than social equity, is a measure of good design of a machine, not a human society. When financial wealth at the top, with growth, exceeds increases of real wages below, inequities in societies increase.
Large size and scale are not always virtues. Human bodies, and large organizations, can become overweight and unhealthy when they become large. When organisms, like the human body, or the Earth’s ecosystem, become unhealthy, their temperatures rise. Inflation is a warning of an overheated and an unhealthy economy in which sectors have become imbalanced. It also signals internal power shifts. Monetary policy is like paracetamol. It can only suppress a symptom of an economy’s poor health.
The purpose of economic development must be to improve all-round human and planetary well-being, rather than increasing the size of economies. A paradigm shift is required in the science of economics to build more resilient and more equitable societies. Economic policy-makers need better models of economies as complex, organic, and living systems, not machines. Values of “fairness” and “societal justice” must drive their models, which so far are designed principally to improve “efficiency” and “productivity” of resources (including humans as resources) to increase sizes of economies and businesses.
PS. The good news is that new models are emerging from the fringes. A new breed of upstart economic journals, such as Evonomics, are giving space to ideas that were shut out by the economics’ priesthood. An article in Evonomics by political economist Blair Fix analyses the causes of inflation in (https://evonomics.com/the-truth-about-inflation-why-milton-friedman-was-wrong-again/).
(This was published in The Economic Times on May 16 2022)