Feedback in the economy

In the Spring issue of the Journal, Oliver Kamm and Pete Lunn addressed the question: ‘What next for the economy?’ According to Lunn, the financial crisis has humiliated orthodox economics and paved the way for a more behaviourally realistic understanding of economics. For Kamm, the crisis reveals less a fundamental problem with the real economy than with one specific sector; and, as such, argues for economic openness over wholesale reinvention. Two articles, from two very different standpoints, generated strong opinion and not a little dissent among the Fellowship. Here, three Fellows respond.
 

A new economics? by John Montgomery
Free trade: at what cost? by Jeremy Fox
The ascent of marketing man by Michael J Baker

A new economics?

The future of capitalism should not be in doubt but lessons still need to be learnt, argues John Montgomery

 

I am writing to say how much I enjoyed the Spring Issue of the Journal, and especially the articles by Oliver Kamm (‘Reversal of fortunes’) and Pete Lunn (‘The descent of rational man’). I agree with Kamm that the economic problem now is primarily a banking panic and that this combined with interest rate policy during 2005-2008 has also triggered the recession. Sorting the toxic debt out is the essential requirement, after which the markets will recover on their own. I disagree with Kamm that governments should print money; nor do I believe that wracking up large debts for stimulus packages is responsible economic management. That way lies debt and inflation.

Pete Lunn’s article is thought-provoking, but in the end I see that behavioural economics can sit comfortably within the neo-classical framework provided by Adam Smith. Lunn omits any reference to Smith’s proposition of enlightened self-interest, and indeed his concept of sympathy. Smith argued that the butcher provided meat to meet need at a price that was beneficial both for the butcher and for his customers. In my town, there are six butcher shops, one part of a supermarket. I always shop at one particular butcher because I like the quality of his produce, don’t mind paying a little more and because we pass the time of day whenever I go into the shop. So this is a behavioural choice on my part. But if the quality declined or the prices became too high, I would switch to another butcher. My choice is exercised within a framework of competition, supply and demand.

Feedback in the economyThe idea that the ‘transaction’ is the ‘atom’ of economics is indeed powerful – and one that has been used in debates over mixed use in cities since the early 1960s. Rather more attention should, in my view, be paid to this simple truth.

But we are still left with the question as to why capitalist economies have booms and busts. Joseph Schumpeter and Nicolai Kondratieff explain this by reference to long-wave business cycles. If true, the theory of long waves would help us to understand that the present recession should have been mild – similar to 1954 or 1958 – but that the banking collapse has made things worse. Long-wave theory, as I read it, suggests we are at the start of a long ‘upwave’. We need to understand where we are in the cycle at any given time.

However, this also means that attempts to smooth out the booms and busts and ongoing peaks and troughs are futile. Indeed, as in the Great Depression or the recent shambles of monetary policy, they make things worse: the troughs are deeper and longer lasting, and the peaks produce higher inflation. Thus it is not the neo-classical economics of Smith or the neo-liberalism of the Austrian School that needs to be jettisoned but the whole expensive and counter-productive edifice of macroeconomics. Rarely can so much money have been wasted on what amounts to alchemy. Wealth creation cannot be turned off and on like a tap, simply by playing around with interest rates or by increasing or decreasing government spending.

The important point to understand is how wealth is actually created.

One way forward from here would be to consider economics as a natural ecosystem or self-generating network, as proposed by Jane Jacobs and Eric Beinhocker. Jacobs argues that ‘economic development is a version of natural development’, is part of the nature of human societies. Economies make themselves up as they go along, just like the English language say. Diverse economies expand in a rich environment, itself created by diverse use of local resources and imported materials. A ‘gene pool’ of work builds up over time, that is of knowledge, skills, techniques and methods. This leads to a type of ‘creative self-organisation’ and a continual and continuing process of adaptation and improvisation. Jacobs refers to this as a form of ‘dynamic stability’, as opposed to critics of capitalism who see it as ‘inherently unstable’. Schumpeter referred to this as ‘creative destruction’.

A by no means trite point is that economic development occurs in real places, usually in advanced cities and their regions, such as London and the South East, Tokyo, LA, Milan and now Shanghai and Bangalore. National economic data may well be easy to collect and mildly interesting, but it fails to account for the great areas of dynamic growth and simply does not recognise the problem of laggard cities and backward regions. The unit of economic analysis should not be the nation state, but rather the city region.

To conclude, I propose that a way forward is:

  • to understand business cycles over 9-, 27- and 54-year periods, so as not to panic over slight downturns or non-existent or self-correcting inflation;
  • to understand supply and demand and price signals (a form of feedback) and what these tell us about the health or otherwise of economies, and especially the ratio of exports to total work;
  • for governments and central banks to abandon the charade of macroeconomics, but maintain control over money supply;
  • to recognise that economic growth and wealth creation depend on a process of continual innovation and improvisation, a set of conditions to which government is not suited;
  • to understand that economic development occurs in real space as well as time, so that dynamic regions should be prioritized over backward places for the purposes of wealth creation. Indeed laggard regions and cities need to learn the basics of dynamic economic development;
  • to appreciate too that successful dynamic economies alter and change by a process of ‘aesthetic drift’, moving in response to myriad influences, signals and technologies – supply and demand, prices, producer networks, consumer choice;
  • to recognise that economies do not respond well to central planning. Because of this, governments who believe in ‘firm, clear decision-making’ and ‘resolute purpose’ will always fail; and
  • to appreciate that economic life cannot be planned; it can only be helped – or hindered.

To repeat, the future of capitalism should not be in any doubt; a return to neo-classical economics bolstered by new knowledge of behaviour and choice should be beneficial; seeing economic development as having similar characteristics to an eco-system should likewise prove fruitful; and getting out from under the dead weight of macroeconomics will be a welcome relief.

Dr John Montgomery is a writer on economics and urban development



Free trade: at what cost?

Jeremy Fox challenges Kamm’s confidence in economic liberalism

Oliver Kamm's ‘Reversal of fortunes’ is simplistic in its analysis and misleading in its prescriptions; little more, in fact, than a genuflection at the altar of received neo-liberal opinion. It contains not a word on sub-prime mortgages and the deepening inequality that gave rise to them; nor does it show any evidence that the author understands how Asian dollar-denominated savings occurred in the first place.

Asian money in the US (and UK) markets was merely a second-stage phenomenon - a consequence of the liberation of western banks from the fetters of reserve requirements which effectively meant that they could lend as much money as they could persuade people to borrow. When the production of money is wholly de-linked from that of goods and services, it usually causes inflation. In the west, the inflationary pressures were attenuated by cheap imports from Asia and elsewhere - except in real estate where importation is, by definition, infeasible. Hence why house prices rose astronomically while other prices remained stable; and why Asia was ‘suddenly’ brimming over with dollars from export earnings. How ironic that when US negotiators grumbled at China for her  ‘undervalued’ currency, they were arguing against one of the bulwarks of the economic process responsible for sustaining the illusion of a low inflation economy - and  the reality of low wages.

Low wages? Afraid so. During the five years from 2000 to 2005, the US economy grew 14 per cent and productivity grew even more - by nearly 17 per cent. Over the same period, median family income - the level at which half the households earn more and half earn less - actually fell by 3 per cent, while unemployment rose slightly. So where did the income from growth go? Mainly to corporate share-owners, company bosses and Wall Street gurus. By 2006, chief executive officer pay was over 250 times that of the average wage. In the 1960s that ratio was only 24 to one.

Therein lies the demand-side source of the sub-prime phenomenon. Those hundreds of thousands, maybe millions, who took out mortgages beyond their means are a direct reflection of increasing inequality and - yes - poverty. People were promised the American Dream and then found - too late - that carpet baggers, corporate directors, and feckless politicians in Washington and Westminster had placed it beyond their reach.

I turn now to Kamm's sublimely confident assertion that ‘the last thing the global economy needs is a resumption of the policies of protectionism.’

This repetition of a standard Brownite (and Cameronite) mantra gives the impression that we have been living - at least up to the onset of the crisis - in a world of largely free and unfettered commercial exchange. Nothing, however, could be further from the truth.  All western countries routinely provide a variety of overt and covert support for nationally-based industries, examples of which are export marketing assistance, trade tariffs, investment incentives, tax holidays, infrastructural projects related to plant location, special utility rates, agricultural subsidies, manipulation of exchange rates, non-tariff barriers cloaked in complex regulations on standards, origin, labelling etc, arcane customs procedures, spurious anti-dumping challenges, and so on. In the United States, a great deal of  assistance to US corporations is provided at state and municipal levels, or through regional agencies such as the Tennessee Valley Authority Economic Development Division, and it passes below the visible horizon of foreign onlookers. In fact, the range of protectionist devices is limited only by the ingenuity of the economists and bureaucrats who are paid to invent them. While most political leaders in the west pay lip service to free trade, many governments beaver away behind the scenes to evade its implications - as the French President appears to be doing by ‘bringing home’ vehicle production jobs from Slovenia, and the President of the United States with his ‘buy American’ plan.

Where the working population is in trouble is if they find themselves governed by leaders who appear genuinely to believe in the free trade nostrum - like Gordon Brown and Peter Mandelson.

Feedback in the economyIt is easy to forget that the vast sums being ploughed into economic recovery by western governments is to be paid for by - you guessed it - western taxpayers. So what an obsessive adherence to open commercial borders may mean is that a goodly proportion of the £300bn and rising that Gordon Brown and co are putting into circulation could be going straight into productive activities in some other part of the world, leaving the UK's unemployed scarcely better off than if the sums had not been spent at all; worse off, in fact, when the increased indebtedness is taken into account.

The question that Obama and Sarkozy are trying to tackle, but that no UK politician or commentator appears to acknowledge is this: why should national taxpayers foot the bill for an economic stimulus package that is not aimed primarily and fundamentally at employment creation in their own country? Put more simply, why should I pay for someone in Slovenia to make cars? Or someone in China to make t-shirts? Are the Slovenian cars and the Chinese t-shirts truly cheaper? In an era of full employment, they might be; but in conditions of unemployment and government deficit financing, their prices rise exponentially. They rise first because I am financing their production, and second because I am financing my own unemployment. In this light, free trade, in the version foisted on the world by the west, is fundamentally flawed. It works most efficiently for countries with full employment; but, as unemployment increases, its efficiency decreases. For developing countries with high unemployment it is plainly nonsensical.  And it is not the way any of the developed countries achieved their privileged status, as Cambridge University 's Ha-Joon Chang convincingly argues in  Kicking Away the Ladder (Anthem Press, London 2002).

Free trade has ever been a siren call of the strong, never of the weak; and it is, in any case, a misnomer. What the politicians and their economist friends mean by the term is forced trade: the commitment by governments to open their country's borders to imports regardless of the wishes of the people or of local economic circumstance. To the degree that such commitments are irreversible, they are clearly undemocratic, and not less so simply because politicians and economic soothsayers claim that they are for the people's benefit.

Trade that is truly free is of the kind that can be declined, and that remains in the hands of the parties to a transaction rather than subject to the terms of a document lodged in the World Trade Organization or a bilateral treaty signed, in all probability, by officials who are no longer either in office or in power. Fair trade, a relatively novel concept, represents the ideal of a universal level playing field in which companies, nations and regions compete as football teams do - with a change of ends at half-time to ensure that no directional advantage accrues to one side. By these definitions, it is doubtful whether international trade has ever been remotely free or fair.

As I write this, the UK car industry is reportedly fighting for survival. Trade theory has it that faltering industries should be left to die, while their workers should retrain for some other - unspecified - activity in which the country enjoys an equally unspecified comparative advantage. But it is the severity of the recession that is hitting the UK car industry, as is also the case in the US, France and elsewhere. Car manufacturing plants that survive will not necessarily be the most competitive or efficient, but the ones receiving enough state aid to nurse them back to health.

Thus, at a time of crisis, while competition between semi-comatose companies dwindles, between national leaders it grows. The smartest (Obama and Sarkozy among them) will ensure one way or another that their key industries live to fight another day; those who are wedded to extremes of free trade ideology can be assured of one thing: they will lose the next election.

Jeremy Fox is a novelist and playwright, and founding partner of management consultancy Fox Jones & Associates



The ascent of marketing man

According to Michael J Baker, it’s marketers not behavioural economists who are key to understanding our market economy and avoiding future crises

The Spring 2009 issue of the RSA Journal contains an essay ‘The descent of rational man’, which promoted the view that ‘orthodox economics has been humiliated’ by the current global economic crisis.

While agreeing with much of Pete Lunn's diagnosis of the failings of orthodox economics, I have less sympathy with the implicit claim that we should seek salvation in the ‘thriving sub-discipline of behavioural economics.’ And the reason I feel this way is because, as someone qualified as an economist, I came out publicly in the early 1960s by accepting an appointment as a Lecturer in Marketing.

I did so because, after six years’ practical experience as an industrial salesman in the steel industry, I was very aware of the important role that selling and marketing play in the success of an organisation but, also, of the lack of professional recognition given to this. So, while Peter Drucker, one of the founding fathers of modern management thinking, might observe that ‘business has only two functions - innovation and marketing’ neither of these functions appeared to be exercising much influence over the strategic management of business firms.

In my view, if we are to avoid, or at least mitigate the likelihood of future economic and financial crises we need to raise awareness of the major role and function of marketing as both a profession and a practice. Economics, like psychology, sociology, anthropology, and other social sciences is a ‘single’ discipline with a clearly defined focus. By contrast, marketing, like architecture, engineering and medicine, is what I would call a ‘synthetic’ discipline in the sense that it seeks to draw upon and integrate the knowledge and insights from a number of other single disciplines.

As a practice, marketing has been concerned with consumption behaviour and the principles of exchange since the dawn of civilisation. As a discipline and body of knowledge its origins are more recent, dating back to around the middle of the 19th century, while the modern marketing concept which underpins contemporary practice only dates back to the 1950s. Since then there has been an explosion in marketing education and academic research into the theoretical foundations on which the professional practice is based. But, despite this, the general public still mistakes the trappings of marketing - advertising, promotion and public relations - with its substance, which is focused on the ‘creation and maintenance of mutually satisfying exchange relationships’.

Feedback in the economyMarketing, and the marketing concept, seeks to promote mutually satisfying exchange relationships as the foundation of sustainable and equitable economic growth and development. In other words, it seeks to promote an ethos of enlightened rather than selfish self interest. While behavioural economics is certainly closer to the real world than neo-classical economics, its concern with individual consumption behaviour still fails to take into account organisational behaviour responsible for the supply of goods and services. Modern marketing with its emphasis upon interaction, networks and relationships does so, and so offers a holistic approach to the management of supply and demand.

Unfortunately, the general perception of marketing is both misguided and ill informed. This is largely due to the fact that it is based upon the marketing management model that developed in the US. This model dominates the content of major textbooks and the curricula of marketing courses. Its emphasis is upon the sale of consumer goods and the actions that need to be taken by a marketing manager to develop an effective 'marketing mix' that will influence consumer demand in favour of their product. In essence, therefore, it is about what marketers need to do to consumers that is antithetical to the marketing concept that regards customers as equal partners in the exchange process and so is focused upon what marketing can do for them.

The American marketing management model has its foundation in the Anglo-Saxon version of capitalism. While this version has been roundly criticised in light of the current financial crisis and global recession, little reference has been made to the alternative Germanic Alpine version that underpins marketing thinking and practice in many other countries. This version of capitalism recognises the need for countervailing power and for a degree of regulation to mitigate the excesses of big business and the cupidity of many involved in its management.

Like its parent, economics, behavioural economics is too narrowly focused to address the problems. With the vision of ‘Bringing together different disciplines and perspectives…’ it is disappointing that the RSA has evidenced little interest in the discipline of marketing, which seeks to synthesise a wide range of both disciplines and perspectives in order to develop real-world explanation of the way that markets work.

Professor Michael J Baker is emeritus professor of marketing, University of Strathclyde