by From Robert Wade Why have the large majority of professional economists, especially in the academy and in western-dominated international organizations like the World Bank and IMF, been committed to free trade policy, downplaying theoretical and empirical weaknesses in order to remain so? The teaching of economics in just about all universities of the western world, and in large parts of the developing world, socializes students into belief in the rightness of the “market” paradigm, and the more “rigorous” the training the more thoroughly socialized they become.[1] The paradigm focuses on price competitiveness – free labor markets, flexible prices, free international trade – as the key to national competitiveness. It treats the market system as “self-organizing”, firms being essentially passive except for competing in price. It treats technology as external to production, as something which firms can buy on the market. It has no built-in process of innovation, no conception of an “industrial ecosystem” of firms competing and cooperating with each other.[2] With all these things stripped out, the culture of the profession elevates belief in comparative advantage and free trade as the litmus test of competence to be an economist, as the earlier quote from Krugman suggests.
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from Robert Wade
Why have the large majority of professional economists, especially in the academy and in western-dominated international organizations like the World Bank and IMF, been committed to free trade policy, downplaying theoretical and empirical weaknesses in order to remain so?
The teaching of economics in just about all universities of the western world, and in large parts of the developing world, socializes students into belief in the rightness of the “market” paradigm, and the more “rigorous” the training the more thoroughly socialized they become.[1] The paradigm focuses on price competitiveness – free labor markets, flexible prices, free international trade – as the key to national competitiveness. It treats the market system as “self-organizing”, firms being essentially passive except for competing in price. It treats technology as external to production, as something which firms can buy on the market. It has no built-in process of innovation, no conception of an “industrial ecosystem” of firms competing and cooperating with each other.[2] With all these things stripped out, the culture of the profession elevates belief in comparative advantage and free trade as the litmus test of competence to be an economist, as the earlier quote from Krugman suggests.
The market paradigm fits the larger “conservative” worldview, which sees the market as ‘natural’ and the realm of ‘freedom’, the state as artificial and the realm of coercion (often predatory coercion). This worldview is not just cognitive (“how the world works”), but intensely normative (“how the world should work”, “the right order of society”).[3] In the market paradigm, the role of government is limited to “correcting market failures”; so state “interventions” in the market have to be carefully justified case by case. Many conservatives do accept the case for taxes to curb some “externalities”, such as pollution taxes to discourage private agents from polluting the environment. Some would even favor a carbon-emissions tax, but not emission regulations (as in Obama’s Clean Power Plan).[4]
In short, the consensus belief in free trade stems from the wider cognitive and normative belief – inculcated in economics education — that the key to economic development lies in improving the scope of, and the institutions of, exchange. Government should strengthen property rights, foster the rule of law, and do what is necessary to align domestic prices with international prices (which means, free trade); and then, having put the right incentive structure in place, get out of the way, allowing the production structure to emerge as the result of profit-seeking investment decisions by private firms, domestic and foreign equally.
The dominance of the market paradigm has hardly been challenged by the new phase of capitalism associated with the hyper-growth of the financial sector and turbo-charged by ICTs. Money funds and shareholders are pressing companies to give priority to success targets such as profits, dividends, and share prices; and to shift production to cheaper sites offshore, using investable funds at home to buy back shares (to boost share prices), as distinct from invest in R&D and training. Stock markets now tend to reward dividends and share buy-backs, not investment.[5],[6]
We see the impacts of the market paradigm in the fracturing of the European Union and Eurozone, gripped by the German and other northwest European countries’ conviction that their own economic success is due to their devotion to the market paradigm – flexible costs and prices, small budget deficits, low inflation, and private utilities. They urge the peripheral countries to follow in their footsteps, with fiscal austerity, labour market deregulation, and privatization. They miss the point that their own economic success comes from a very different production and employment system than exists in most of the periphery (Greece, Portugal and southern Italy, for example).[7]
Both the contrast in economic performance within the European Union, and my critique of the globalization agenda, can be understood in terms of the much less favored ‘production’ paradigm. As Ricardo is the source of the market paradigm, Charles Babbage is the source of the production paradigm, in the form of his 1832 book, On the Economy of Machinery and Manufacturers.[8] His successors included Alfred Marshall, Allyn Young, Edith Penrose and George Richardson. It is a fair bet that most economics PhD students in Anglo universities have never heard of these people, let alone read them.[9]
The production paradigm says that the core mechanism of how economies transform (or not) lies in the combination of production capabilities, business organization, and economic governance; or what Michael Best calls the “capability triad”.[10] Economies with high capability pivot on a sufficient density of “entrepreneurial” firms which pull basic and applied R&D or production and marketing ideas from MNCs with branches in the economy in question, into innovation in products, processes, organizations, and marketing. These entrepreneurial firms do not emerge by themselves as a natural result of a well-working market. Their own internal capacity development requires a larger ecosystem of finance, skills and S&T partnerships; which depends on trust in social interactions, and therefore physical and/or cultural proximity. The government (national or regional) is the organizer, the steward of the infrastructure needed to support this ecosystem. “Macro stabilization” has a supporting, not driving role. Well-known examples are Boston’s Route 128, Silicon Valley, the Third Italy, and Germany’s mittelstand and similarly organized small and medium enterprises (less than 500 employees) in Austria, Denmark, Finland, Netherlands, Switzerland.[11] The most spectacular transformation of all is Singapore, which, like Ireland and Malaysia, aggressively invited in MNCs and also, unlike those cases, carefully developed national capacity to pull more complex production and technology from corporate headquarters to local operating divisions in Singapore and from there to national firms.
From this point of view, the standard argument that: “it is OK, in terms of the national interest, for firms to offshore their ‘scale-up’ production provided ‘start-ups’ with their knowledge stay at home” is mistaken, because (a) innovation depends on building on experience of production, “learning while doing”, and (b) scale-ups are where the jobs are, not the start-ups.[12]
Germany’s economic performance, and in particular its large trade surpluses, comes out of the production system codified in the production paradigm – combined with the longstanding agreement between government, business and labor to hold down wages and domestic demand.
Britain, on the other hand, is a sad case of the costs of following the market paradigm. British manufacturing (with exceptions) was slow (compared to northwest Europe) to introduce interchangeable parts, a culture of “continuous improvement”, profit-sharing reward incentives, team-based multi-skilled work organization, minimal separation between managers and workers, and heavy investment in vocational education. Britain remained stuck with piece-rate incentive systems, elaborate job classifications, sharp hierarchical separation between managers and workers, even as its manufacturing firms lost more and more market share.[13] By way of compensation, the government undertook ad hoc industrial policy with subsidies, tax concessions and material infrastructure driven not by a national or regional strategy but by electoral calculation and intense lobbying in the shadows.
British-owned road car manufacturers were wiped out by foreign firms assembling in Britain – which imported two thirds of their parts and components in place of domestic production. The British government did little to encourage them to deepen their production in Britain, saying, in the spirit of the market paradigm, “If they can get cheaper parts elsewhere, then they should do it”. The Japanese, Korean and Taiwanese governments would have had a more developmental mindset.
Britain’s low level of output per hour productivity relative to its peers (a bit over three quarters of the US, German and French levels, about the same as Italy, and stagnant since 2007) has been the subject of much research and anguished commentary. The conclusions typically point to: (1) poor infrastructure (rated by the OECD as second worst in the G7); (2) low investment in R&D (at 1.7 percent of GDP in private and public R&D, well below the OECD average, let alone the leaders on over 3 percent of GDP); and (3) a relatively unskilled population, which cannot drive productivity forward.[14]
Strangely overlooked as causes of Britain’s low productivity are: (4) British companies have for two centuries invested relatively heavily overseas compared to at home (the opposite in Germany, Japan, South Korea). (5) The economy has become dominated by finance, with its demands that British companies give priority to success targets such as profits, dividends, and share prices; and use investable funds at home to buy back shares so as to boost share prices. Finance has also had a backwash effect on the “real” economy, attracting highly skilled people to work in finance by offering remuneration many times that available elsewhere. (6) Britain’s captains of industry and its financial magnates are zealous champions of the market paradigm. So they rubbished the government’s green paper on industrial strategy published in early 2017, saying that the solution to lagging productivity is not “industrial strategy” but cuts in regulations – even though OECD measures show that Britain’s labor and product market regulation is low and about the same as in the US.[15]
Emphasising the costs of the last three points would challenge the core of the market paradigm in a way that emphasizing the first three does not. Meanwhile, all the attention is on the costs of Brexit, which will be small compared to the loss from low productivity.
Is Trump wrong on trade? A partial defense based on production and employment
[1] As one example, G. Racko, et al., 2017, “Economics education and value change”, Academy of Management Learning and Education, January.
[2] The Crash of 2008 and the ensuing Long Recession, and the experience of taking economics undergraduate courses which made no mention of these events, prompted three Manchester University students in 2011 to form the Post-Crash Economics Society to explore how to get a wider range of approaches into the curriculum. The movement has spread to 43 student campaigns in 15 countries. It is unified around the drive to shift economics from a public no-go area, occupied by a tiny minority of the population who speak the profession’s language; and around the drive to introduce more critical thinking, more evaluation, into exams – which currently are comprised mostly of multiple-choice questions to be answered on the basis of rote learning repeated under invigilation. The original three students have written a book, reviewed by Aditya Chakrabortty, 2017, “The Econocracy review – how three students caused a global crisis in economics”, The Guardian, 9 February,
https://www.theguardian.com/books/2017/feb/09/the-econocracy-review-joe-earle-cahal-moran-zach-ward-perkins. See also A. Chakrabortty, 2013, “Mainstream economics is in denial: the world has changed”, Guardian, 28 October, at:
http://www.theguardian.com/commentisfree/2013/oct/28/mainstream-economics-denial-world-changed
[3] For a discipline so strongly normative, it is paradoxical that economics is an ethics-free zone, lacking relevant teaching, journals, newsletters, conferences or even professional codes (the latter until very recently, and then very partial ones). See G. DeMartino and D. McCloskey (eds.), 2016, The Oxford Handbook of Professional Economic Ethics, Oxford University Press; and E. Fullbrook, 2016, Narrative Fixation in Economics, World Economics Association Books.
[4] M. Feldstein, T. Halstead, N.G. Mankiw, 2017, “A conservative case for climate action”, New York Times (International), February 10.
[5] William Lazonick, 2014, “Profits without prosperity”, Harvard Business Review, September; OECD, 2015, Business and Financial Outlook, Paris.
[6] For a discussion of how mainstream economists’ deep normative commitment to the market paradigm blinded them to the build-up of the causes of the Crash of 2008 and subsequent Great Recession, see R. H. Wade, 2016, “Economists’ ethics in the build-up to the Great Recession”, chapter 15 in G. DeMartino and D. McCloskey (eds.), The Oxford Handbook of Professional Economic Ethics, p.268-292
[7] R. H. Wade, 1982, “Regional policy in a severe international environment: Politics and markets in South Italy,” Pacific Viewpoint, 23(2), October: 99-126; Wade, 2012, “Greece, breaking the doom loop”, Le Monde Diplomatique (English), blog, 6 July.
[8] Babbage is credited with inventing the mechanical calculator and pushing for the high precision engineering necessary to build such machines, and being one of the first to infer general principles of effective production from close observation, which Ricardo-inspired economists did not do.
[9] On the World Bank’s full-on embrace of the market paradigm starting in the 1980s, and move away from helping to boost borrowing countries’ production capabilities, including material infrastructure, see R. H. Wade, 2015, “Agenda change in western development organizations: from hard production to soft, timeless, placeless policy”, Lahore J. of Economics, 20: SE, September, pp. 1-12.
[10] This section draws on Michael Best, forthcoming (2017), How Growth Happens: The Economics You Were Never Taught, Princeton University Press.
[11] For the role of US government agencies in forming innovation-focused networks of competing and cooperating firms, see R.H. Wade, forthcoming (2017), “The American paradox: ideology of free markets and practice of directional thrust”, Cambridge J. Economics.
[12] See Andrew Grove, 2010, “Andy Grove: how American can create jobs”, BloombergBusinessweek, July 1. https://www.bloomberg.com/news/articles/2010-07-01/andy-grove-how-america-can-create-jobs. Grove was co-founder and CEO of Intel. He says, “As happened with batteries, abandoning today’s ‘commodity’ manufacturing can lock you out of tomorrow’s emerging industry… Our fundamental economic belief, which we have elevated from a conviction based on observation to an unquestioned truism, is that the free market is the best of all economic systems – the freer the better… [Evidence that this is not true] stares at us from the performance of several Asian countries in the past few decades. These countries seem to understand that job creation must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal. In a thorough study of the industrial development of East Asia, Robert Wade of the London School of Economics found that these economies turned in precedent-shattering economic performance over the ‘70s and ‘80s in large part because of the effective involvement of the government in targeting growth of manufacturing industries.”
[13] See the dramatic contrasts between organization in a British-owned factory in Britain and a Japanese-owned one making similar products, in Ronald Dore, 1973, British Factory-Japanese Factory: The Origins of National Diversity in Industrial Relations, George Allen & Unwin, London.
[14] Martin Wolf, 2017, “The productivity challenge to the British economy”, Financial Times, January 27.
[15] Nicholas Oulton, 2017, “Productivity puzzle meets delusions of adequacy”, letter, Financial Times, February 8.