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threebooksIn our PhD Economics program at Stanford, we learnt nothing about the history of major economic events of the twentieth century. Instead, we were taught the rather arcane and difficult skill of building models. In order to analyse what would happen in an economy, we learnt that you have to construct an artificial economy, populated by rational robots called homo economicus, who behave according to strict mathematical laws. At no point in our studies were we asked to match what happens in our models with any events in the real world; it was assumed that the two always matched. This process of economic modelling permits us to provide exact mathematical answers to a vast range of questions one might ask about the economy. This is undoubtedly a powerful technique, which has earned economics the name “Queen of the Social Sciences”. Our poor cousins in political science, psychology, sociology, geography, and so on, have to study the more complex real world, and cannot offer anything comparable. Nonetheless, the power of mathematical modelling derives from the extremely unrealistic assumption that real world events and human behaviour can be predicted by mathematical formulae. Thus, the precise predictions of economists are often dramatically contradicted by real world outcomes. As Nobel Laureate Paul Krugman remarked after the global financial crisis took economists by surprise: “the economics profession went astray because economists, as a group, mistook beauty, clad in impressive-looking mathematics, for truth.”

My own education in economics began many years after graduate school, when I chanced across a copy of Economics and World History: Myths and Paradoxesby Paul Bairoch. Bairoch’s book challenged one of the holy cows of economic theory, that free trade is always a superior policy for all parties. Believing in free trade is a hallmark of economists — a recent survey showed that 90 per cent of economists believe in it, while only 20 per cent of the general public believe that free trade is always optimal. So it came as a shock to me when Bairoch discussed many historical episodes to show that free trade had caused harm to the less developed nations, by preventing development of industries, and also by creating unemployment. Many nations with strong industries had built them up under the umbrella of protection, contrary to free trade principles. This historical evidence was strongly in conflict with the mathematical demonstrations of superiority of free trade that I had learnt in graduate school. In bewilderment, I asked several of my mentors, very senior and respected economists, about this. I was even more surprised by the responses I received. None of them were familiar with the historical evidence, and furthermore, they did not find it relevant. They argued that if protection provided good results, then free trade would have provided even better results. The mathematical proofs were impervious to empirical evidence.

Economists do not study history because it is a record of particular events, while they search for universal scientific laws, which would be equally valid among the Aztecs and the Zulu, in the nineteenth century and in the twenty-first. I realised that the laws of economics hold only in an imaginary world populated by robots, and that to learn real economics, it was necessary to study history, which I had bypassed in graduate school. It was only after many years of detailed historical studies of real world economic events that I came to realise that nearly everything I had been taught in graduate school was wrong.

Recent historical events have shaken the faith of many true believers in free market economics. A landmark 2013 study by Autor, Dorn and Hanson, found that competition from China has destroyed jobs and lowered wages in many US industries, especially manufacturing. Contrary to economic theory, which states that the displaced labourers will find better jobs in different sectors, workers displaced by Chinese competition often went on the government dole. A large group of heterodox economists, students and laymen are becoming increasingly aware of the lack of realism, ideological bias, and lack of concern with poverty and inequality, which are hallmarks of modern economic theory. However, dissent is weak and dis-united, while orthodoxy is firmly entrenched in the halls of power. The task of creating a new economics remains as essential as it is undone. 

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Newspaper article published in Express Tribune, on 25th May, 2015 Pakistan. It explains the defects of the fractional reserve banking system, and suggest switching to 100% reserve banking.

A long time ago, Ibn-e-Khaldoon noted the tendency of conquered nations to unthinkingly imitate the conquerors in all dimensions of life. After achieving freedom from colonization, the former colonies have tended to imitate or retain the colonial institutions, without reflecting on whether or not these institutions are suitable for them. In his classic, “Small is Beautiful,” Schumacher showed that appropriate technology for developing countries was often small and low-tech production techniques which empowered the people. Imitating the highly capital intensive and large scale industries of labor short capitalist countries is like trying to run before learning to walk. Today, large dams are being built all over the world at enormous financial and environmental costs, while smaller scale agile energy producing technologies which deliver quick results cheaply are being ignored. Similarly, we have retained colonial institutions which were designed to be top-down, hierarchical, and non-democratic; people being heavily taxed and exploited cannot be allowed to have a vote in the matter. Transiting to democratic institutions requires many reforms. For instance, the “police force” which maintains order by force, needs to be re-conceptualized as the police service, responsible for the security and protection of citizens.

Banking is another institution that has been copied without a cost benefit analysis. The Great Depression of 1929 was caused by a banking crisis which wiped out lifetime earnings and led to prolonged misery for millions. Stringent banking regulations prevented major crises for fifty years. Financial liberalization in the 1980’s led to the Savings and Loan crises; the bailout was more than the profits of banks for the entire century. Since the 1980’s financial de-regulation has been extended and globalized, resulting in more than 200 banking crises globally, with huge economic costs. The latest and greatest is the Global Financial Crisis of 2008, which cost trillions of dollars, and led to the highest levels of homelessness and hunger seen in the USA since World War 2. Overall, when we add up the benefits and subtract the costs of current banking systems, the net result is tremendously negative.

Many have analyzed the reasons for repeated banking crises, and found that the root cause is the fractional reserve banking system. In this system, banks holding a billion Rupees can freely create a large multiple – like five or ten billion Rupees – from nowhere. They only need to have a small fraction of the money that they create to give to lenders. The inherent injustice of a system which allows certain wealthy private parties to create money at will is hidden from public view. Henry Ford said that “It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” An inherent feature of the system is that the claims on banks are far greater than their assets. When too many depositors wish to withdraw money, there is bound to be a crisis. In the words of Lord Mervyn King, the former Governor of the Bank of England “Of all the many ways of organizing banking, the worst is the one we have today – change is I believe inevitable. The question is only whether we can think our way through to a better outcome before the next generation is damaged by a future and bigger crises.”

The excellent documentary “Inside Job” shows that Iceland was badly mauled in the GFC 2008. Financial de-regulation crashed a small stable and robust economy, due to wild and excessive lending. Iceland Bankers, utilizing their powers of money creation, expanded the money supply by a factor of twenty over the decade leading upto the GFC 2008. The bloated money supply led to soaring prices of stocks and lands, and ultimately crashed the economy. The Central Bank of Iceland found that, contrary to what is written in monetary theory textbooks, it was completely unable to control the money supply. It utilized all the tools at its disposal, including raising the discount rates to extremely high levels, but could not prevent the private banks from creating excessive money.

Chastened by the experience of helplessness, watching an impending crisis without being able to do anything about it, the Iceland government has recently formulated a plan for monetary reform. The key ingredient of the plan is that the power to create money is taken away from the private banks. The proposed system of “Sovereign Money” puts the power of money creation in the hands of a panel of specialists at the Central Bank. They would use economic theory to create money in quantities which would allow for full employment without creating inflation. Specialists can download and read the Iceland proposal for monetary reform, full of fascinating details and information about the defects of our current banking system. The question of ‘why only Iceland?” when this reform is needed everywhere was addressed briefly in my previous article on The Shifting Battleground. A much more detailed historical explanation of the power and craftiness of the financial lobby is given in the writings of Ellen Brown.

The main problems of current banking system are that it is unjust, crisis prone, and anti-growth. Private money creation leads to a rentier economy, where the largest profits are made by owners of wealth, who invest in stocks and land, and earn interest on bonds. The producers, laborers, and farmers who make up the real economy, get very little reward for their labors. Instead, rewards accrue to the financiers who provide money – created from nothing – to all the real sectors. Not only is this unjust, but it causes growth prospects to shrivel, since all investment is directed towards financial sectors, and away from the productive sectors. Studies show that growth of GDP is very strongly correlated with the amount of investment in the real sector, and in human beings. This is only natural: growth is directly tied to how much we invest in our future. Although it is radical, the Iceland Plan for monetary reform offers the possibility of a dramatic increase in real investment and real growth, very much needed today in Pakistan.

Endnotes:
1. See also an intelligent critique of the Iceland Proposal at Re-inventing Money

2. See also my paper on “An Islamic Version of the Iceland Plan for Monetary Reform” — this extends the plan by adding the elimination of interest from the banking system.

There is widespread agreement on the proposition that people act according to their self-interest. Marx went further to suggest that people subscribe to ideologies conforming to their class interests. For example, agricultural laborers would believe in land reforms, while big landlords would believe that small farms are inefficient. Gradually the weight of strong empirical evidence has led me to understanding that this proposition is false. Large segments of the population can be brought to believe in, and act according to, ideologies extremely harmful to their self interest. As Dani Rodrik has written in How the Rich Rule, political scientists Gilens & Page found that on issues where there was a conflict between the interest of the elite and that of the public, Congress voted in favor of the elite and against the public interest. In the past, the elites have enforced their interests by the use of power. In a democratic age, the same effect is achieved by the use of propaganda. This is striking because the propaganda must convince the public to act against their own self-interest, in favor of the ruling elites. It would seem that you can fool most of the people most of the time. Here is some empirical evidence for my thesis: Read More

The Great Depression of 1929, and now the Great Recession following the Global Financial Crisis, poses several puzzles for economists. One is them is the sudden and severe drop in aggregate demand. This leads firms to curtail production, and therefore reduces demand for factors of production, most importantly labor. Why does aggregate demand fall, and why do not the price adjustment mechanisms restore equilibrium? The outstanding contribution of Atif Mian and Amir Sufi in House of Debt (see my Review & Summary) is to explain both why aggregate demand fell and also why the standard price adjustment mechanisms fail to restore equilibrium. The correct explanations have eluded famous economists like Keynes, Friedman, Lucas and many others . Only after understanding the reason for the shortfall in aggregate demand does it become possible to prescribe a remedy.

(see also discussion following repost on RWER Blog)
Read More

Since it was posted in Aug 2013, this post has been almost continuously among the top ten posts on the RWER Blog, and attracts nearly a 1000 hits every month. Revised & updated on 25/12/2017;  Previous Version (rev 16/9/2016); Original Post (29/8/2013).

Ever since the spectacular failure of modern economic theory became obvious to all in the Global Financial Crisis, the search for alternative ways of organizing our economic affairs has intensified. The vast majority of alternatives under consideration offer minor tweaks and patches, remaining within the methodological framework of neoclassical economics. In contrast, Polanyi offers a radical alternative, with unique insights based on a deep study of the history of the emergence of capitalism. A major obstacle to understanding Polanyi is the fact that living in a market society shapes our mindsets and behaviors, making it difficult to imagine radical alternatives. Understanding Polanyi requires standing outside the streams of history which have shaped modern societies, to see how our economic, political and social theories about the world have been shaped by external forces, and have evolved in time. Studying this archaeology of knowledge offers us insights into the historical processes which have shaped our thoughts, and gives us the tools necessary to liberate us from the narrow boundaries created by our own past experiences.

The central theme of Polanyi’s book is a historical description of the emergence of the market economy as a competitor to the traditional economy. The market economy won this battle, and ideologies supporting the market economy won the corresponding battle in the marketplace of ideas. Today, the victory of the market economy is so complete that it has become difficult for us to imagine societies where the market does not play a central role. Polanyi argues that contrary to popular belief, markets have been of marginal importance in traditional societies throughout history. The market economy emerged after a prolonged battle against these traditions. As Polanyi clarifies, this is not a good development. The commodification of human beings and land required by the dominance of the market has done tremendous damage to society and environment. The value of human life has been degraded to their earning power. This enables the grim calculations made by Ambassador Albright that sacrificing half a million Iraqi children is worth the control of oil. Similarly, precious rainforests, coral reefs, plants, fish, and animal species which took millions of years in the making, and cannot be replaced at any price, are reduced to the value of timber, food or chemicals. This is the root cause of the social and environmental catastrophes we currently face. The analysis of Polanyi can be summarized in the six points listed below.

1: All societies face the economic task of producing and providing for all members of society. Modern market societies are unique in assigning this responsibility to the marketplace, thereby creating entitlements to production for those with wealth, and depriving the poor of entitlement to food. All traditional societies have used non-market mechanisms based on cooperation and social responsibility to provide for members who cannot take care of their own needs. It is only in a market society that education, health, housing, and social welfare services are only available to those who can pay for it.

2: Market mechanisms for providing goods to members conflict with other social mechanisms and are harmful to society. They emerged to central prominence in Europe after a protracted battle, which was won by markets over society due to certain historical circumstances peculiar to Europe. The rise of markets caused tremendous damage to society, which continues to this day. The replacement of key mechanisms which govern social relations, with those compatible with market mechanisms, was traumatic to human values. Land, labour and money are crucial to the efficient functioning of a market economy. Market societies convert these into commodities causing tremendous damage. This involves (A) changing a nurturing and symbiotic relationship with Mother Earth into a commercial one of exploiting nature, (B) Changing relationships based on trust, intimacy and lifetime commitments into short term impersonal commercial transactions, and (C) Turning human lives into saleable commodities in order to create a labor market.

3:  Unregulated markets are so deadly to human society and environment that creation of markets automatically sets into play movements to protect society and envirnoment from the harm that they cause. Paradoxically, it is this counter-movement, this opposition to markets, that allows markets to survive. If this was not present, markets would destroy the society and the planet. For example, the Great Depression caused the collapse of many free market institutions, and the government stepped in to prop them up and substitute for them. Similarly, only massive government intervention save the world from a major economic crisis following the Global Financial Crisis of 2007. This protective, anti-market, move allowed capitalism to survive. This is called the “Double Movement” by Polanyi, who says that the history of capitalism cannot be understand without looking at both sides — the forces trying to liberate markets from all regulations, and the forces fighting to protect society from the harmful effects of unregulated markets.

4: Certain ideologies, which relate to land, labour and money, and the profit motive are required for efficient functioning of markets. In particular, both poverty, and a certain amount of callousness and indifference to poverty are required for efficient functioning of markets. Capitalist economics require sales, purchase, and exploitation of labor, which cannot be done without creating poverty, and using it to motivate workers. The sanctification of property rights is another essential feature of markets. Thus, the existence of a market economy necessitates the emergence of certain ideologies and mindsets which are harmful to, and in contradiction with, natural human tendencies.

5: Markets have been fragile and crisis-prone and have lurched from disaster to disaster, as amply illustrated by GFC 2007. Polanyi prognosticated in 1944 that the last and biggest of these crises in his time, the Second World War, had finally killed the market system and a new method for organising economic affairs would emerge in its wake. In fact, the Keynesian ideas eliminated the worst excesses of market-based economies and dominated the scene for about 30 years following that war. However, the market system rose from the ashes and came to dominate the globe in an astonishing display of power. This story has been most effectively presented by Naomi Klein in The Shock Doctrine: The Rise of Disaster Capitalism.

6: Market economies require imposition by violence — either natural or created. As noted by the earliest strategists, deception is a crucial element of warfare. One of the essential ingredients in the rise of markets has been a constant battle to misrepresent facts, so that stark failures of markets have been painted as remarkable successes. There are a number of strategies commonly used to portray an economic disaster as progress and development. Without this propaganda, markets could not survive, as the forces of resistance to markets would be too strong. For example, a fundamental message of modern economics textbooks is that capitalism has created tremendous wealth and unprecedented progress. In fact, notwithstanding capitalist propaganda to the contrary, this growth has been extremely costly. We have sold planet Earth and the future of our children, and are celebrating the proceeds without taking into reckoning the costs. Accounting for the costs of destruction of environment, animal species, and human society, shows that that costs of growth have been far higher than the benefits. See “Evaluating the Costs of Growth” (September 21, 2014). Real World Economics Review, issue 67, 9 May 2014, page 41-51.. Available at SSRN: https://ssrn.com/abstract=2499115.

We conclude by briefly considering the consequences of this analysis. The organization of production in a capitalist economy rests essentially on the exploitation of laborers, and requires using poverty as the goad to moltivate laborers to work. This means that if we provide universal basic incomes, we will remove the incentives for production which lie at the heart of capitalist systems of production. Instead, Polanyi suggests that we focus on ensuring that all people have the right to earn a decent livelihood. This can be accommodated within the present systems of production without radical change. Long run solutions require more radical changes in mindsets which would reverse the great transformation by prioriotizing social relationships and subordinating the market to the society.

I recently recorded a half-hour talk discussing the material summarized in the above post. The video is linked below:

Supplementary Readings and Videos:

For a more complete list of papers/videos/posts on Polnayi, see: Resources for Study of Poplanyi’s Great Transformation

Polanyi’s analysis cannot be understood by modern economists because it is based on methodological principles radically different from those currently in use.  The Methodology of Polanyi’s Great Transformation explains these principles, which demonstrate the necessity of considering historical and cultural context of economic theories. Polanyi’s analysis provides the basis for a radically different approach to economics, which considers politics, society, environment, and economics as inter-related subjects which cannot be understood in isolation.

The relationship between the Great Transformation and the looming environmental catastrophe which threatens the future of humanity on planet Earth is discussed in Zaman, A. “Unregulated Markets and the Transformation of Society” Chapter 18, Routledge Handbook of Ecological Economics: Nature and Society. Editor Clive Spash. 2016. A brief summary of this paper, and a video-talk on the topic is available from another post on this blog: “Markets & Society

A 30 page article, which provides further details of this brief sketch,  can be downloaded from the link below:   “The Rise and Fall of the Market Economy,” Review of Islamic Economics, Vol. 14, No. 2, 2010, pp. 123–155. This post, and the connections to Islamic Economics, are explained in my blog: “An Islamic WorldView“.

 

Karl Paul Polanyi (1886 – 1964)  is known for his opposition to traditional economic thought and his book, The Great Transformation.  The Great Transformation was written in the interwar years but not published until 1944. Polanyi is known for his opposition to the emerging Austrian school of formal economic method. Methodologically, the Austrian free-market group of economists, that included Ludwig von Mises, defended abstract quantitative economic models based on the assumption of Homo oeconomicus.  The associated policy recommendation fosters market liberalism. The “natural” free markets without state intervention would function efficiently.

Polanyi’s critic is oriented to the Homo oeconomicus – all-knowing self-interested decision maker that maximizes choices combining considerations of opportunity cost, marginal utility and price. His critique is also oriented to the free markets as a “natural” setting.

Indeed, Polanyi is remembered today on behalf of his cultural approach to economics which emphasized the way economies are historically embedded in society and culture. This view ran counter to mainstream economics but has been popular in anthropology, economic history, economic sociology and political science.

Full text: http://uncharted.org/frownland/books/Polanyi/POLANYI%20KARL%20-%20The%20Great%20Transformation%20-%20v.1.0.html

 

 

from Jack Reardon

A spirited debate on the reformation of economics education is welcomed and necessary. I am thrilled to participate in it. The key word is education: we need to educate our students and the public, rather than proselytize, which unfortunately is too often the modus operandi of neoclassical economics. Proselytization is little different from bullying and no better example of this was written by Edward Fullbrook as a chapter in my book (Handbook of Pluralist Economics Education) and has circulated on the internet. Education is our most important endeavor as human beings: t is absolutely necessary for ourselves, our planet and the future generation.

While I think we are agree on the need to educate rather than proselytize, a much more difficult question is what is education and what does it mean to educate? And a related question is what should we be teaching our students. To answer the first question, I believe the key to education is to foster doubt about existing institutions- why are they structured as is? Who benefits? Where is the locus of power? Can the existing situation be improved for all rather than the select few? Another key in education is to foster humility and respect for other views. This doesn’t mean we must agree with everyone; on the contrary, disagreement (and doubt) is necessary for the advancement of knowledge.

The goal of reforming economics education is too important to exclude either specific beliefs or a specific modus operandi. We should welcome all suggestions, and all blueprints for change, from the barely nudging to the radical reformation. A pluralist tent for reforming economics education should be broad enough to harbor all views. To exclude any one view is to mirror the myopic and self-defeating practice of neoclassical economics.

We have much to learn from each other and I don’t want to limit my own learning by restricting who I can dialogue with. I view the above distinction as artificial and counter-productive. Instead I view the comments as different degrees of the same objective: the reformation of economics education.