The Profession of Economics and Its Enemies >>>>> (Part 1 of 3) — The Conflation

Abstract

        Markets are financial in nature and are a function of business. An economy is the
        amalgamation of markets but is not, itself, a market. Unlike markets, the goal of 

        an economy is man-made.

Economics has long carried the label of ‘the dismal science’. This label can be attributed to a failure on the part of the discipline of economics to properly conceptualize its role and its objectives. The birth of this profession sprang from a time when social interactions and livelihoods underwent significant changes. Self-sufficiency became a thing of the past as division of labor became an organizing principle. In this era, industrialization thrived, and capitalists became the new nobility. As financial forces coalesced, business ruled supreme, and labor became a commodity. Markets were formed and the best organized had their way. Once it became clear in the 20th century that economies could not be managed in terms of markets, the ‘dismal science’ admonishment might have withered away. That it has not is evidence the lessons of history have not yet fully been realized.

The larger issues associated with this failure are examined in three parts. Part One focuses on the structure and goals of an economy. Part Two will examine the way economics is taught. Part Three will consider the profession’s interface with the political. This three-part series is intended to uncover the root causes of economic performance that are needlessly harmful to many.

                                                                  Two Camps

From the advent of markets up to the Keynesian period of enlightenment, capital and the capitalists have set the agenda. Markets were king and were viewed as the engine of social progress. The economy, imagined as a market, was viewed as self-correcting and was thought to administer justice.

With the publication of The General Theory of Employment, Interest and Money by John Maynard Keynes in 1936, many began to question standard economic dogma. In the throes of the Great Depression, the concept of effective demand became valued. Hard experience proved that when consumers had too little money to spend, business activity was compromised. The hands-free approach to economic policy that allowed the economy to seek its own level offered no respite to the cold and hungry. At that point, the discipline of economics divided into two camps: the market-oriented economists who held onto the self-regulating concept of free-markets and the more progressive camp who saw governmental intervention in the economy as necessary.

Economists today are overwhelmingly market oriented. Most would have us believe that economies require minimal intervention. To support their position, they cite the role that the forces of supply and demand play in establishing market equilibrium. Others, however, see economic performance as distinct from market considerations requiring thoughtful policies to maintain economic equilibrium. One camp advocates for a hands-off approach while the other argues for active intervention. This essay will show how the conflation of financial principles with economic principles has prevented an economic consensus.

                                                          A Metaphor

Most understand the workings of a market, where the law of supply and demand sets prices. As quantities increase, prices decrease; as quantities decrease, prices increase. The law is almost intuitive. On the other hand, active intervention requires knowledge of economic issues. To help one better understand the difference in approach, a metaphor is offered.

Let an iceberg represent the economy. Most of the iceberg is not observable from a ship at sea. Let the visible part above the waterline represent the economy where economic policy takes place. The mechanics of good public policy are developed here. The much larger part hidden below the surface represents the part of the economy where resource markets work their magic. While part of the same structure, with regard to forces that act upon it, two separate and distinct conditions exist.

Above the waterline and in the societal portion of this metaphor, the relation of aggregate output to aggregate demand is measured within the context of equilibrium. This is where the money supply and consumer buying power set the tone for economic performance as profit seekers compete for market share. Monetary and fiscal policies that spur or retard economic activity are forged in this portion of the metaphorical iceberg. Forces that are brought to bear above the waterline are distinctly unique to the discipline of economics.

Beyond the immediate control of economic policy and below the waterline, competitive markets, governed by the law of supply and demand do battle. Business strategies are either accepted or rejected by market forces. It is in this arena that business enterprises work to satisfy the demands of consumers.

While part of the same structure, different objectives are at play within each portion of this structure. One force acts upon aggregates and the other acts upon units of production. The challenge for the economic discipline is to distinguish between the two parts and to maintain focus on the portion where economic policy takes place. This is no small task.

                                                          Blind Spots

From inception, economies have been viewed as the purview of business. Decisions that affect economic performance have been judged in relation to business principles. Because of that, the discipline of economics has incorporated many blind spots into its profession. These blind spots are doctrines that get treated as economic in nature but, in scope, belong to the province of the entrepreneur.

The concept of laissez-faire is one such example. This long-established principle holds that to be most efficient, governments should limit or exclude the regulatory framework within which business operates. Translated literally as “allow to do as they choose,” laissez-faire says to leave business alone. Those who adhere to this doctrine argue that an unregulated marketplace will benefit everyone by way of Adam Smith’s invisible hand. Laissez-faire is a plea from the business community for non-interference in its quest for profit maximization. This plea is financial in nature and does not represent economic policy.

The business strategies of global comparative advantage and local competitive advantage are also not economic principles. They represent the environment in which businesses choose to compete but say nothing regarding the management of an economy, nor should they. Economists have no interest regarding comparative advantage or competitive advantage. These strategies belong to the entrepreneur and fall well below the metaphorical waterline.

A final example of a business principle superimposed onto the field of economics is the law of supply and demand. This law supersedes its authority when used in the context of economic policy. Forces of supply and demand have a price setting function and help to allocate scarce resources within a defined market. An economy, however, is not a market and requires no price setting function. The price of a good or service is relevant to a business practice. Price is determined by many factors, none of which involve the economy wide aggregation of supply and demand. An economy is governed by forces outside of the financial principle of supply and demand.

These three examples point to the fact that the profession is saddled with tactics best suited to business strategies and the pursuit of profit. The goals of business and the goals of an economy are not the same. Imagining the needs of business to be the needs of society defies logic. Suggesting the market price of goods and services to be congruent with good economic policy requires magical thinking. Business principles considered to affect economic performance are, by definition, financial in nature and have no place within the development of economic policy.

                                                             Conclusion

A well-functioning economy will tend to the needs of all stakeholders. When economic principles are conflated with financial principles, the ability to ensure equal opportunity is lost. The profit seeking motive of business does not speak to the wider community.

An economy has its own set of needs that must be addressed above the fray of market activity. Active intervention is necessary. Regardless of how beautifully markets self-regulate in setting price for the business community, incorporating market principles into the discipline of economics misrepresents the needs of an economy and ultimately the needs of those it intends to serve.

Economists must establish the profession as a social science and distinct from the world of business. The discipline of economics must define its rightful identity and put an end to the label of ‘the dismal science.’

                                                                 References

      Carlyle, Thomas, 1849. "Occasional Discourse on the Negro Question", Fraser's 
      Magazine for Town and Country, Vol. XL., p. 672.

      Keynes, John Maynard, 1936. The General Theory of Employment, Interest and 
      Money. London: Macmillan      

      Krugman, Paul & Well, Robin, 2009, Macroeconomics, 2nd Ed., Worth Publishers, 
      New York 

     Mankiw, N. Gregory, 2007. Principles of Economics, Fourth Ed., Thomson, Mason, 
      Ohio, pp. 407-408
 
Karl Popper is acknowledged as the inspiration for the title of this three-part essay.