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The economic and financial turmoil engulfing the world marks the first crisis of the current era of globalization. Considerable country experience has been accumulated on financial crises in individual countries or regions which policymakers can use to design remedial policies. But there has not been a world financial crisis in most people’s living memory. And the experience of the 1930s is frightening because governments at that time proved unable to preserve economic integration and develop cooperative responses.
Even before this crisis, globalization was already being challenged. Despite exceptionally favorable global economic conditions, not everyone bought into the benefits of global free trade and movement of capital and jobs. Although economists, corporations, and some politicians were supportive, critics argued that globalization favored capital rather than labor and the wealthy rather than the poor.
Now the crisis and the national responses to it have started to reshape the global economy and shift the balance between the political and economic forces at play in the process of globalization. The drivers of the recent globalization wave – open markets, the global supply chain, globally integrated companies, and private ownership – are being undermined, and the spirit of protectionism has re-emerged.
Moreover, the debate on the existing conventional economic wisdom and political choice now became on the fore. As part of this debate, many argued that a profound challenge to the conventional economic wisdom is essential. Because while there were undoubtedly many failures of economic theory and public policy specific to the financial system itself, those failures existed within and were nurtured by a wider dominant consensus. That conventional wisdom manifested itself in the political economy as much as in technical economics. Paradoxically, in the realm of political economy, one of the tenets of the conventional wisdom was to deny the feasibility or importance of political choice.
The existing economic conventional wisdom had three key tenets. First, the key objectives of economic policy and indeed of public policy more generally, are well known. It is economic growth, rising prosperity, increasing GDP or GDP per capita. It is for this reason why politicians usually focused on the economic issues and campaigned on a preferred message such as “It’s the economy, stupid. Vote for me, and the economy will grow more rapidly.”
Secondly, the means by which growth will be maximized, and that is essentially through market liberalization, deregulation as the route to economic efficiency in all product and service markets, free trade and free capital flows as crucial drivers of economic development and catch up and financial market liberalization and increased financial intensity as the route to efficient dispersal of risk and efficient allocation of capital.
And third, inequality is justified because it creates incentives which make markets efficient, which in turn generates growth. Inequality doesn’t matter much as long as prosperity is rising, with absolute income important to human well-being, while concerns about relative income a product of unattractive envy.
These three propositions have formed an internally consistent and self-reinforcing belief system, a belief system which then can be and has been used to challenge the possibility of political choice whether on the environment or on income distribution. Many believe these tenets derive directly from economics, indicating that the dismal science is all about showing us how constrained public choices are.
Instead, new economic thinking has to restore the recognition of economics as a tool for elucidating political choices. And to do that, it has to challenge assumptions about objectives as well as means and question in particular all three of the dominant tenets of the last 30 years. On objectives, the crucial question is how important economic growth, as measured by national income accounts, is to human welfare.
Of course, many economists would deny that economics has ever said that maximizing growth is the objective. But it is clear that many practical men and women in finance ministries and industry and commerce departments think that economics says that growth should be the objective. Again another important question worth to ask is this: Does economic growth deliver increased welfare, or well-being or self-perceived happiness or whatever people think the objective is? It is difficult to avoid the issue, but it is a deeply contested one.
The work of the economists Richard Easterlin, Bruno Frey and Richard Layard has suggested a clear answer to the above question. Increasing prosperity, measured however imperfectly by standard GDP per capita measures, matters a lot to human happiness or well-being as you go from the per capita income of Africa today to that of the developed world of, say, the 1950s or 1960s. But once a person reach that level, further growth delivers no further benefit. However, those findings have in turn been challenged by researchers such as Justin Wolfers, who find some correlation between self-perceived well-being and increasing GDP at all income levels. Having looked carefully at both arguments, the viable conclusion is that once you have reached high levels of income, the relationship between further growth and further welfare enhancement is uncertain and complex. More growth is perhaps capable of producing increases in human welfare, but it is not certain to do so. And there are certainly many good theoretical reasons for doubting whether further economic growth will limitlessly make people more content. A few from the many are as follows.
The straightforward process of satiation and declining marginal utility gives a hierarchy of human needs. For example, one winter coat keeps a person warm. A second winter coat gives him perhaps important but certainly secondary benefit of fashion and style. The increasing importance, once basic human needs are met, of competition for relative status, for instance via the consumption of premium branded goods and fashion items. The increasing importance of limited supply positional goods, above all housing in the most pleasant locations, so that even individuals not concerned per se with relative status, have to win in a competition for relative income to achieve absolute utility goals.
All these factors combined with the empirical evidence suggests that it is difficult simply to assume that increased measured GDP will deliver increased well-being even if it might be under some circumstances. Foresightful economists were warning 75 years ago to be careful about attaching too much importance to measures of GDP.
An American economist, Lionel Robbins, in his writings in the mid-1930s when national accounting conventions were first being developed, argued strongly that measures of “social income,” as he labeled the aggregate figure, only had meaning and usefulness in relation to monetary policy and stabilization policies. He argued that they were adequate for dealing with such issues because they can deliver useful information about year-by-year variations. But in relation to the end objectives of economic activity, Robbins wrote, “The addition of prices or individual incomes to form social aggregates is an operation with very little meaning.” Many people may have learned this in their undergraduate economics study, but it is too often ignored and forgotten nowadays.
But economics cannot ignore the issue of what the ultimate end-objectives are. It is because the answers have real implications for policy. The arena is an uncomfortable one for those who like clear mathematical models because it raises philosophical issues: Is happiness the overall objective? Is it the same as well-being? If people were happy under a dictatorship, would that be okay? And where does justice enter the picture? If 99.9% of people were ecstatically happy in the face of the persecution of a small minority, presumably that is not an acceptable result.
Thinking about end-objectives such as well-being requires the use of measurement techniques such as surveys of self-perceived contentment, which are clearly quite as imperfect and shot through with methodological difficulty as any GDP accounting. For this reason, many in the economics profession are now becoming doubtful that the aim should be to replace GDP with some new measure, say like, gross national well-being. But the absence of the perfect alternative should not make them content with the measure they have got. Economics must elucidate questions about end-objectives, not assume what the objectives are in order to give people something to model.