Globalist Paper

The Need to Challenge Conventional Economic Wisdom: Part III

What is the best measure of economic success — the growth of GDP or well-being and happiness?

Takeaways


  • Rejecting the conventional justifications of growth, markets and inequality still leaves in place a powerful liberal case for economic freedom and for growth as the likely byproduct.
  • If you do not allow talented, energetic, driven people to compete in markets and keep a significant share of their gains, they will compete in other, more destructive ways.
  • Reasonably free markets and personal economic freedom may be important to human well-being, even if further growth in income is not all that important.
  • Good economics leaves us with far wider degrees of freedom to make political and social choices than has frequently been asserted. The role of good economics is to inform those choices, not to deny their possibility.

If economic growth is not so important for rich countries, freer markets are not always superior in delivering growth — and if inequality matters, do we have to embrace a sort of radical green egalitarianism that is:

  anti-growth because of its sometimes harmful side effects;

  and against markets because they tend to produce inequality?

I disagree with radical green egalitarianism. I think there is a case for growth, for markets and for some non-trivial resulting inequality. But it is a different one, and indeed an older and more political case than that put forward by the instrumental conventional wisdom of the last 30 years.

First on growth: Further increases in average income may not have the potential to increase contentment in already rich countries, but the possibility of growth and the process of growth itself may be vitally important to contentment in the modern world.

The expectation of technological progress, of innovation, of changing styles and fashions, may be important to my sense of well-being, even if once the expectation is satisfied no permanent increase in happiness will result.

Given that I know that the electronic gadgetry I own today has not made me permanently happier than I was 20 years ago, it is unlikely that further generations of products will make me permanently happier in the future. But I would be unhappy if the economy became static, if products and services didn’t get better or simply became different.

The journey matters, not the destination. Which, of course, is a culturally relative statement: for it may be that there could exist societies in which people are happy within a permanently unchanging lifestyle. (Bhutan scores highly on happiness surveys.) But while my assumption of desirable change is culturally relative, it is not a mindset from which modern societies have the capacity to escape.

For the great transformation of the last two centuries rested on, and itself generated, institutions and cultural assumptions which commit us to perpetual change. But we have to manage its consequences. The process of growth may be important even if the end result is not. And reasonably free markets and personal economic freedom may be important to human well-being, even if further growth in income is not all that important.

  First, because without reasonably free markets and price systems and personal incentives, economies may not only fail to maximize growth, they may actually regress and atrophy. (Think of the Soviet Union in its final decades.)

  But second, and more fundamentally, because there is an argument for market freedoms which exists independent of allocative efficiency benefits. As Amartya Sen puts it, “The merit of the market does not lie only in its capacity to generate more efficient culmination outcomes, but in the processes by which those outcomes are achieved.”

Suppose, he asks, that contrary to Friedrich von Hayek’s propositions, a centralized Soviet economy of directed labor and administered prices had been as effective as the market economies in delivering GDP growth. Would that have been a desirable outcome?

The answer is surely no, because as Sen puts it, “The freedom of people to act as they like in deciding where to work, what to consume and what to produce” is an end in itself and an important element of freedom.

A crucial justification for economic freedom therefore exists independent of any allocative efficiency benefits and is still valid even if rich developed countries have reached a point where further growth in GDP has limited and uncertain potential to deliver permanent increases in human well-being. And economic freedom is likely in turn to generate a reasonable level of economic growth, but with that perhaps best understood as an acceptable byproduct, rather than the objective itself.

If we have reasonable economic freedom to innovate, to set up a new business, to compete, to take one’s labor elsewhere, there will be significant inequality. So there exists a political and philosophical justification for inequality which has little to do with the benefits that flow from incentives, but is fundamental. It derives from people’s right to keep a significant share of the income they earn in free exchange with others.

And there is also an argument rooted in a realistic assessment of human nature, which says if you do not allow talented, energetic, driven people to compete in markets and keep a significant share of their gains, they will compete in other, more destructive ways.

As John Maynard Keynes puts it in “The General Theory,” one of the benefits of the market and of non-trivial inequality is that “dangerous human proclivities can be canalized into comparatively harmless channels by the existence of opportunities for money making and private wealth, which if they cannot be satisfied in this way, may find their outlet in cruelty, the reckless pursuit of personal power and authority and other forms of self-aggrandizement. It is better that man should tyrannize over his bank balance than over his fellow citizens.”

That may seem a very negative justification for markets and resulting inequality, but possibly a far more powerful one than the conventional assertion that inequality drives better incentives, which drive growth, which delivers human well-being.

Such arguments for markets, for economic freedom and for some resulting inequality take us back to a more political economy, to the discipline of political economy which existed before the mathematization of the neoclassicists.

As John Hicks, himself of course a key figure in the mathematization of economics, recognized, “The liberal principles of the classical ‘Smithian’ and ‘Ricardian’ economists were not in the first phase economic principles. They were an application to economics of principles which were thought to apply in a much wider field. The contention that economic freedom made for economic efficiency was no more than a secondary support.”

So rejecting the conventional justifications of growth, markets and inequality still leaves in place a powerful liberal case for economic freedom and for growth as the likely byproduct. But it’s a very different justification, and very different implications follow for policy in many areas. Let me suggest two:

  First, stability matters a lot. The same evidence of well-being and happiness that casts doubt about whether long-term growth maximization is all that important, says that recessions and debt crises are very bad for human welfare, because even if higher income doesn’t make people permanently happier, they deeply dislike setbacks to income and wealth levels already achieved, and because involuntary unemployment is very bad for human welfare.

  Second, we need policies to lean against increasing inequality. There are certainly limits to our ability to do so — avoidance and evasion dangers, international competition for ability. But they are almost certainly less severe than has typically been asserted. There is a choice to be made.

My general point is that good economics leaves us with far wider degrees of freedom to make political and social choices than has frequently been asserted. The role of good economics is to inform those choices, not to deny their possibility — and that is a pretty good guiding principle for new economic thinking.

This series of articles was adapted from the author’s presentation at the Institute for New Economic Thinking’s conference at Bretton Woods, New Hampshire, on April 8, 2011. Published with the consent of the author.

Part I | Part II | Part III

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About Adair Turner

Lord Adair Turner was appointed UK Financial Services Authority Chairman in September 2008.

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