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Rethinking economics: going beyond efficiency

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Angus Deaton, Professor of Economics, Emeritus, at Princeton University and the 2015 recipient of the Nobel Memorial Prize in Economic Science, in an article titled "Rethinking My Economics" published in the March issue of the International Monetary Fund's (IMF) Finance and Development magazine wrote, "Like many others, I have found myself changing my mind, a discomforting process for someone who has been a practising economist for more than half a century". He views, mainstream economics is in "disarray".

The 78-year-old Professor is questioning many of the assumptions about the "dismal science" which he and his peers have long entertained. He calls for a radical rethink of deeply entrenched views in the face of rising inequality. He raises issues of power, ethics and efficiency among others and points out that it ignores the reality of power, it neglects questions of equity and the focus on efficiency has become a "licence for plunder". He also laments the demise of unions, questions the virtues of free trade and immigration and their impact on American workers.

He recognises the importance of efficiency, but also says "we valorise it over other ends". He points out, "Keynes wrote that the problem of economics is to reconcile economic efficiency, social justice and individual liberty. We are good at the first, and the libertarian streak in economics constantly pushes the last, but social justice can be an afterthought".

Deaton argues, "Our emphasis on the virtue of free, competitive markets and exogenous technical change can distract us from the importance of power in setting prices and wages, in choosing the direction of technical change, and in influencing politics to change the rules of game". He further notes, "Without an analysis of power, it is hard to understand inequality or much else in modern capitalism". He further added, "Yet today we are in some disarray. We did not collectively predict the financial crisis and, worse still, we may have contributed to it through an overenthusiastic belief in the efficacy of markets, especially financial markets whose structure and implications we understood less well than we thought."

Following Deaton's view, it can be argued that mainstream economists imbued with neoliberal doctrinaire views are in a thrall to combine extremely simplistic assumptions with extremely complex mathematical models to provide empirical evidence in support of their ideological position but with no relevance to the world where people live their everyday lives.

How power distorts functioning of a free market-oriented economy has been well recognised for a considerable period of time not only by economists but also non-economists. The distorting effects of large corporations and the power they exercise on inflation and the decline of unions on wage growth are well recognised. Behind the scenes the role of large corporations to influence politics to change the rules of the game has also been long recognised.

More importantly modern capitalism in its neoliberal form has rendered states powerless and unions ineffective. It has only increased certainty for corporations and reduced that for its competitors, consumers and working people by their ability to use power to "change the rules of the game".

Deaton pointed out, "Their (unions) decline is contributing to the falling wage share, to the widening gap between executives and workers, to community destruction, and to rising populism".

We have witnessed over the last one decade or so this rise in populism which includes the fascist and religious-ultra nationalists' cult figures like Donald Trump in the USA, Georgia Meloni in Italy, Narendra Modi in India, Jair Bolsonaro in Brazil and Javier Milei in Argentina. They exploited various real or politically motivated and crafted grievances using divisive populist slogans to get to power.

Deaton points out that in contrast to economists like Adam Smith and Karl Marx through John Maynard Keynes, Friedrich Hayek, even Milton Friedman, mainstream economists have largely stopped thinking about ethics and about what constitutes human well-being. His argument emphasises how economics is taught is critical. The curriculum needs to be made more relevant to real life issues. Therefore, ethical issues are critical, especially on the issue of fairness.

On the question of trade, he says, "I am much more sceptical of the benefits of free trade to American workers, and even sceptical of the claim, which I and others have made in the past that globalisation was responsible for the vast reduction in global poverty over the past 30 years".

He also said that he no longer buys into the narrative that trade has been a driving force behind poverty reduction in India. Despite NITI  Aayog's (it serves as the apex public policy think tank of the Government of India) claim that the proportion of poor people in the country declined from 24.8 per cent to 14.9 per cent  during the period from 2015-16 to 2019-21, but a new study published this month has claimed that wealth disparity is at its highest in decades. India's richest 1 per cent of the population earned 22 per cent of country's income and owned 40 per cent of wealth during the last financial year.

The study further claims that wealth distribution is now more unequal than during the British colonial rule. Despite the claims of continuing robust economic growth and poised to be the third largest economy in the world within the next three years, GDP per capita (nominal) stood at only US$2,612 in 2023 making it 140th in global ranking in terms of per capita income during the same year. Only 12.3 per cent of an estimated 471 million workforce in India have regular jobs with some form of job security provided by laws, others are just surviving under various forms of informality. However, NITI Aayog data on poverty reduction has also been questioned by a number of academics and researchers on the methodological grounds both within India and outside.

As for China, he contends that its road to relative prosperity has been achieved through wage stagnation and decline of workers in rich countries-- if Chinese policies had not been so focused on savings, allowing more of its manufacturing growth to be absorbed at home. But China does not see it that way rather believes that as the world economy is currently clouded by upheavals and uncertainties, China is creating new opportunities for businesses worldwide as well as global growth in its pursuit of high-quality development and Chinese modernization (see Xinhua, March 25).

Many Chinese also believe that the country's economic achievements have come about because of, not despite, China's current form of government. Also, there is a widespread belief within the country that the adherence to the socialist market economic system and model of economic development has enabled China to achieve its spectacular economic development.

In his book "Economics in America: An Immigrant Economist Explores the Land of Inequality", published in October last year by Princeton University Press, he said that after arriving in the US 40 years ago, he soon realised that he had run headlong into libertarian monetarists of the Chicago School of Economics, and they were driving US policy.

He also observed that there was a strong libertarian belief that inequality was not a proper area of study for economists. And an unfettered free market would deliver greater economic equality and individual liberty, and that government intervention and regulation would undermine both.

Deaton highlights in the book two major flaws in the efficiency-based view of free market economies and economists. One is where economists who strongly oppose minimum wage is a good example of the profession's shortcomings, by laying too much emphasis on efficiency (by market solutions) and ex-post redistribution without considering ex-ante pre-distribution. The second flaw revolves around free trade. He argues that even if the free trade gains within a country are much higher than losses, they are very unevenly distributed and the hypothetically possible compensation rarely gets paid. In a democratic system working class people without receiving the promised compensation can contribute to the rise of a populist leader like Trump in the US.

Deaton expressed the view that the political system in the US is "more responsive to the needs of those who finance it than to its constituents". The way poverty is measured and the issue is addressed by the government has turned out to be "the war on poverty has become a war on the poor".

In a written interview with the Institute of Art and Ideas (iai) late last month, Deaton said that economics has redefined itself as a technocratic enterprise largely concerned with efficiency, with how best to allocate limited resources. Also, economists often implicitly adopt some version of utilitarianism or avoid ethics altogether.  But philosophers think about human wellbeing, as well as about social justice.

A large body of empirical evidence is available that open economies have economically performed much better than closed economies. A 2021 study found that across 151 countries over the period 1963-2014, "tariff increases are associated with persistent, economically and statistically significant declines in domestic output and productivity, as well as higher unemployment and inequality, real exchange rate appreciation, and insignificant changes to the trade balance". Even if free trade is considered not fair, it is beneficial for countries engaged in trade.

It is important to look beyond finger pointing at China for the difficulties faced by American workers. The US economy has undergone tremendous structural changes over the last three decades or so with implication for employment, particularly unskilled workers.

The current protectionist policies sponsored by politicians in the US are ostensibly about favouring domestic industries over foreign suppliers. In doing so, in practice, they put some Americans 'more first' than others. More importantly, it will help materialise what Deaton fears -- the exercise of "power" by the powerful in the US.  Therefore, such protectionist policies are as susceptible to being controlled by powerful special interests as any other government activity and that will be very difficult to do under a free trade regime.

Also, a country that maintains 800+ military bases across the world and constantly at war in Europe, the Middle East and other parts of the world like in the South China Sea also needs to be factored in to get a grasp of the functioning of the US economy and the problems that the country faces including its working people.

It is indeed surprising to see that Deaton's article has appeared in a journal published by the IMF which has long been seen as the standard bearer of neoliberal economic orthodoxy. The IMF lost its primary mission when the international financial system moved away from the gold standard to a floating exchange rate system. It is also clear that the IMF's approach to economic development has been a colossal failure.

The publication of the article in an IMF journal possibly appears to signal that the IMF is attempting to develop some degree of interest to see how its "one size fits all" neoliberal hardline simplistic policy application is impacting on countries at the receiving end.

This aspect was reflected in IMF Managing Director Kristalina Georgieva's  speech delivered at Kings College, Cambridge on March 14. She said that "there have been policy errors - especially a failure to do enough to support those hit hard by dislocation from new technologies and trade". She also called for a different type of growth - one that is more sustainable and equitable, emphasising the need to reduce inequality.

In his thought-provoking article Angus Deaton questions current economic thinking -- overenthusiastic belief in the efficacy of markets as well as touching on issues such as power, ethics, efficiency, union and free trade. These are subjects that need debate. In fact, debate around these issues have never gone out of fashion, they just come and go in a circle. But the problem, as Keynes had observed, "lies not so much in developing new ideas as in escaping from old ones".

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