Cracks in the Edifice of Economic Orthodoxy

It has been very interesting reading The Economist over the last year or two. The magazine is unashamedly pro-market, indeed it was founded upon such principles 175 years ago. Yet it is also honest, analytical and self-critical, to its eternal credit. What has been happening lately is these two pillars have been pulling in opposite directions. The pro-market consensus that became accepted orthodoxy during the Reagan years has been shown to have flaws, which The Economist has usually been honest enough to expose.

The victory of pro-market ideas had itself been stunning. In the sixties and seventies the trade unions had abused their power, and the fatal flaws of communism as it had been practiced in the USSR became apparent. This created space for a popular crusade based on individualism and challenge to welfare. Reagan and Thatcher grabbed the space with enthusiasm and took into further. It became acceptable not just to punish the weak, but also to reward the successful exorbitantly, indeed the concept of performance related pay became accepted as a necessary price for success, even as levels of greed among executives and, even more, their bankers and advisors, became ever more mindboggling. Progressive taxes were slashed, and all state services branded somehow inefficient.

There was more. Trade was promoted as a universally good thing. Regulation was challenged as damaging. Free movement of people was also promoted, this one sotto voce since immigration never sat well with the public consensus behind the orthodox policies. The financial sector even managed to create new sectors from pensions and student loans, their greed not satiated by other boons from deregulation and globalisation.

The political victory of this orthodoxy was akin to a revolution. In the US and UK, Clinton and Blair led notionally progressive parties that accepted the orthodoxy in full. Communism collapsed in Russia, and morphed in China towards something close to the same orthodoxy, now an uncomfortable poster-child for that mantra. As The Economist highlighted last week, in Europe the left is still in retreat and lacks compelling ideas, tied as it remains to trade union funding.

But slowly cracks began to appear. At first these were ignored as teething troubles or poor execution or inevitable costs to set against greater benefits. But the cracks have become wider, and The Economist has bravely been ready to expose them, albeit cautiously.

The main thing they have had to acknowledge is the results. Since the orthodoxy took hold, median real incomes in Western societies have stalled. The financial crisis was an embarrassing breakdown of rampant deregulation. And those societies that have embraced globalisation and small government the most have built up unsustainable debts. Less noticed, growth per capita has actually been slower in the US than in Europe during this period; despite the trumpeting that the US is stronger, it is only immigration that has fed what growth there has been.

As these fissures have become too large to gloss over, The Economist has been reduced to defending some key principles while accepting flaws in others. It has been a good debate, and promises to remain compelling reading for some time. Of course, I have the blessing of being able to enjoy the debate from a position of some financial security, and others, for example Port Talbot steelworkers, would prefer more urgency and action than debate.

Performance related pay is one area of renewed scrutiny. Enron went some way towards exposing the greed and the risks behind the model, where managers, far from incentivised to find sustainable growth, warp the model for their own ends. What is less written about is how such abuse is often fed by advisors and bankers, especially when it involves fees from financial engineering, debt management and M&A. There was always a flaw in claiming that low paid workers needed the threat of redundancy to work hard, while managers needed ever greater rewards to remain motivated.

Last week The Economist mounted a sound defence of shareholder value, the guiding principle behind this movement, but accepted that execution had been flawed and that some regulation was required to rein in excess. I agree that shareholder capitalism is a wonderful thing, and also that it can be improved by giving better information and power to shareholders. But, in the meantime, why not restore some progressive taxes and crack down on offshore finance too?

Another Economist article a few weeks ago bemoaned the increasing concentration in US industries and argued for more competition. As a consumer I agree – things like hygiene products have obviously rigged markets here. The entire market-based ethos requires intense competition to work, so it was interesting to read Zero to One by Peter Thiel arguing that the only businesses worth developing are those where some sort of monopoly can be engineered. Financial markets require high returns, so should we be surprised if businesses try to lobby to inhibit competition?

The Economist argues for some further break up of regulation, notably in intellectual property. Certainly, lobbying has led to congress promoting the wrong form of regulation. Incentives to innovate are important, and we should celebrate firms like Google, though even here the story of American exceptionalism and a small state is somewhat thin, given that it is the military that developed the uniqueness of many of its global leaders.

But the real problem comes from impure markets, such as healthcare. Here, even with privatisation, government continues to play a role, and consumer information at the point of sale is limited. There are many such sectors, and there require new thinking, for the orthodox model creates undeserved wealth while nationalisation creates inefficiency. The answer lies in finding the right balance of regulation – which in the case of the US is more not less, and determined by experts not biddable politicians.

One of the more interesting debates is about trade. The Economist has always lauded trade, and in my opinion with good reason. This week, they made a further defence, against mounting rejection on all sides of the US election. But again they have been forced to recognise that their analysis was shallow. True, new benefits are large, and we should not forget that without trade we would have a lot less choice and higher prices in many sectors. But the losers from trade are many and the economic and social impact on the losers severe. You only have to visit a former coal-mining or ship-building town in the UK to observe this.

The Economist now says that trade should still be promoted, but more should be done to soften the blow for the losers. This argument becomes even stronger when held against another article in the same episode about the Belgian town of Vilvoorde. Here, the Renault factory closed down twenty years ago, and since then the town has become a feeding ground for would-be Jihadists.

Other tenets of economic orthodoxy have been challenged too. The austerity policies promoted after the crisis by many governments are now questioned as being too protective of established wealth. Calls to reducing welfare payments have now been balanced, even to the extent of guaranteeing minimum family incomes, recognising that full employment is no longer attainable and that many have little chance of finding well-paid work. Minimum wages have been cautiously accepted as sound, and there have even been muted calls for stronger unions – seemingly part of the fault for the Euro crisis lay with German unions not demanding high enough wage increases! I have yet to read of The Economist advocating a Tobin tax, but perhaps that will be next.

It is good to see this greedy and heartless edifice crumbling at last, though the damage that has been done is irreparable. What would be really sad is if the thoughtful analysis of The Economist is drowned out by populism. Shareholder value, trade and even small government have merit, and immigration has huge benefits, but politics is dictating that these good things may be sacrificed. Instead, progressive taxation, Keynesian government intervention on infrastructure and fairness for losers would be a better mantra, and perhaps there is scope within the political spectrum for such a platform to emerge before it is too late.