Talk to The New Institute, Hamilton
August 28, 2007
I’ve now been a journalist for 33 years, spending all that time working for the Sydney Herald and virtually all of it as an economic journalist. So I thought what I’d do tonight was tell you a little about my intellectual pilgrimage over that time – how my views about economics have evolved. I should start by telling you that, though I have a lot of economics in my degree, I make no claim to be an economist. What I was when I came to the Herald 33 years ago was a chartered accountant. I used to tell people I was an accountant pretending to be an economist, but these days I prefer to say I’m a journalist who writes about economics. That gives me a little bit of distance from the economists, a bit of independence, making me a kind of interpreter and go-between between the profession and my readers. Not so much a theatre critic as an economists critic.
I have to tell you that, after 33 years, my enthusiasm for the subject matter of economics – figuring out how economies work, determining what motivates people in the economic aspects of their lives – is greater than it’s ever been. The subject fascinates me – I love making new discoveries about economics and then passing them on to my readers. My ideal holiday is to take a box of new books on economics – most of them bought on Amazon – up to the weekender we rent on the central coast and just sit on a banana chair in the backyard devouring them.
But I also have to tell you that, partly as a result of that reading, I’ve had increasing doubts about conventional economics – doubts at the theoretical level and the practical level. Most economists are pretty smug about the success of their discipline. They ignore their appalling record as forecasters and think the profession has a pretty good handle on how the economy works. But I think economics is hugely primitive. In the 230 years since Adam Smith we’ve uncovered a few basic truths about economic behaviour, but what we don’t know far exceeds what we do. That’s why the forecasting is so bad – we’ve got only the roughest idea of how the economy works.
The core of conventional economics is still what’s called the neoclassical model – the idea that price is determined by the interaction of supply and demand. Economic rationalists are people who take this model and, rather than using it as an analytical tool that you pull out of your kitbag when you think it’s the right tool for the job, elevate it to the status of a religion – a fundamentalist religion. And, like all fundamentalist religions, it has features that some people find very attractive: a few simple rules that, provided you have faith, explain the whole world. It gives you the illusion of certainty and an answer to every question. You can apply the model to any economy, any industry, any market – and the fact that you don’t know much about the specific circumstances is no problem. The model’s answers are always simple and universal.
Now, I don’t want to knock the neoclassical model and its religious devotees completely. Market forces are very real and very powerful. You frequently see people changing their behaviour in response to changes in prices. Market forces are often like a balloon – you can try to repress them, only to see them pop up elsewhere in a distorted form. Black markets are the obvious example.
And the great virtue of economic rationalists, at their best, is their opposition to economic privilege: to producers using some form of monopoly power – whether natural, business-made or government-made – to reduce competition and give themselves an easy, profitable life at the expense of their customers. Many, perhaps most, industries and professions try this on to a greater or lesser degree. In the argy-bargy a few years ago over medical indemnity, I was most entertained to watch the fisticuffs between the two professions that just about invented economic privilege: the doctors and the lawyers. I’ve been thinking that, these days, the race is not so much to the swift as to the industry that best uses the media to win public sympathy for the preservation of its economic privilege – particularly as the political parties become more poll-driven and intent on staying in power by giving the public what it says it wants. The economic rationalists have an analysis, known as public choice, which says that just about all government intervention in industry, no matter how well-intentioned, ends up being captured by the industry being regulated and manipulated so as to advantage the producers over the consumers. I’m afraid there’s a large measure of truth to that analysis.
But that’s enough praise of economic rationalists and the neoclassical model. The model seriously oversimplifies real-world markets and economies. It focuses on one often very important factor – price – while ignoring a lot of other potentially important factors. It assumes that buyers and sellers have roughly equal bargaining power – which is often not the case. We’re hearing more about this lately as farmers and other small businesses complain about being squeezed by big business, such as the two supermarket chains (though the small businesses usually forget to mention that most of the cost savings get passed on to supermarket customers).
Another assumption of the conventional model is that both buyers and sellers have complete knowledge – about the qualities of the product being exchanged and about all the prices being charged by other sellers. In reality, sellers usually know far more about these things than buyers do, giving them a significant advantage. This ‘information asymmetry’ explains a lot of the problems and ‘market failure’ in markets. It’s what allows doctors to over-service their patients and allows the CEOs of public companies to enjoy salary packages many times greater than the value of their contribution to the firm.
The conventional model assumes away the importance of institutions – including laws and social norms of behaviour – that are critical to the efficient functioning of markets. It’s only recently, for instance, that model-blinded economists have realised the valuable role that ‘trust’ and other aspects of social capital play in lubricating a market economy. But other important institutions include the well-enforced law of contract, bankruptcy law, accounting standards and trustworthy auditors. Economists’ failure to understand this simple truth – because it’s not part of the model – led to them having a hand in some terrible disasters in recent times, such as the Asian crisis (where developing countries with utterly inadequate commercial infrastructure were urged to open their financial markets to hugely destabilising ‘hot money’ flows of foreign capital) and the badly botched transition to capitalism of Russia and other formerly planned economies.
Another significant weakness in conventional economics is its assumption that economic agents (people) always act rationally – that is, with clear-headed self-interest. The relatively new school of behavioural economics, which draws heavily on psychology, has demonstrated that people’s behaviour is often far from rational. People are emotional and often exhibit herd behaviour, particularly in share and property markets. People don’t even act with an understanding of such basic economic concepts as opportunity cost. With such a flawed model of human motivations as its basis, is it any wonder the economists’ model is such a hopeless predictor of economic behaviour?
Now let me say a little about my new book, Gittinomics. In all the interviews I’ve done to publicise it, only one interviewer has come close to saying the obvious: you have to be pretty egotistical to name an -omics after yourself. So what’s so special about my version of economics? All capitalist economics seeks to explain how the capitalist system works. I guess what’s different about my take on the subject is its emphasis on making sure you’re a master of the system, not a victim. Making it work for you, not you for it.
To that end, the first thing to understand is the need to keep economics in perspective and economists in their place. Economists are experts in one important but limited aspect of life: the material. No one knows better than they do how best to maximise our production and consumption of goods and services. When a community follows their advice - as we pretty much have been for the past 25 years - it gets rich.
Trouble is, sensible people don’t maximise the material aspect of life, they optimise it. That is, they balance it against other, non-material objectives. For instance, most economists know little about the question of fairness and, for the most part, they ignore it. Press them and they’ll tell you frankly that it’s outside their area of competence. Likewise, they’re largely oblivious to the social and spiritual aspects of life. Will the policies they advocate damage family life, for instance? Sorry, never given it any thought. Why don’t you consult a social worker or a priest? Why not indeed. Economists’ advice is one-dimensional. When we give that advice primacy and fail to meld it with the advice of experts in other areas, we risk becoming a richer but more socially dysfunctional society.
And what applies at the national political level also applies in our everyday lives. Most of the things capitalism has to offer us are good - provided we don’t overdo them. Trouble is, the system is usually pressing us to overdo them. Take the ready availability of credit. Thanks to financial deregulation and our return to low inflation, interest rates are lower and the banks are anxious to lend. When we use that credit to buy our own home, we’re generally better off. But when we use credit cards or home equity loans to buy consumer goods we can’t afford, we risk becoming victims.
Credit cards don’t remove the need to save for the things we buy. Since debts have to be repaid, they merely allow us to do the saving after we’ve acquired the item rather than before. The trick is that you also have to pay a lot of interest. So when we allow our impatience to get the better of us, we end up devoting much of our income not to buying things but merely to paying interest. And if carrying a lot of debt on top of our mortgage makes us feel continuously weighed down - I owe, I owe, it’s off to work I go - that’s another strike against our being masters not victims. It’s great to live in such a successful capitalist economy, where not all but most of us enjoy a fair degree of comfort. But when we take the advertising too seriously and start deluding ourselves that buying more stuff will make us happy, we risk becoming victims.
Our politicians venerate the ‘aspirational voter’, but when our aspirations run exclusively to the material we’re setting ourselves up for a state of recurring dissatisfaction. To be masters of the system we need to control our aspirations, learning to be more content with what we’ve got and aspiring to be better gardeners, better golfers, better at our jobs, better partners, better parents, better human beings.
The capitalist system has ways of taking money from the poor, but also of doing down the comfortably off. Really? How? By selling the illusion of social status - and it doesn’t come cheap. The middle class spends an enormous amount of money keeping up with the Joneses and trying to demonstrate how well we’re doing by the clothes we wear, the cars we drive, the homes and suburbs we live it, the schools we send our kids to and much else. Almost by definition, the possessions that most impress people are the ones that cost most. There are too many cases where, provided they get their image and market positioning right, firms can defy the laws of demand and supply and sell more of their product by putting up their price.
What makes this game an illusion is that it’s like an arms race. People are always catching up and passing you, requiring you to earn more and spend more to regain your place. But if you’ve got the money, what’s wrong with spending it on big boys’ toys? Nothing - provided keeping your place in the status race doesn’t lead you to money stress, overwork, a feeling of being trapped or neglect of relationships that matter most.
If it does, you’re a victim. And here’s a good test of whether you are: how much do you enjoy your job? If you’re just doing it for the money, and feel constrained by your financial commitments from moving to a lesser paid but more satisfying job . . . well, you don’t need me to tell you you’re not master of your destiny. But your cage is of your own making. How can you escape to a better job or cut back the long hours you’re working? By reducing your financial commitments. How? By controlling your material aspirations and stopping trying to buy status. Is that too tall an order? Then don’t complain about being trapped by the system.
But wouldn’t the capitalist system collapse if we all cut our spending and did less work so we could spend more time enjoying our relationships? No, of course it wouldn’t. The economy would just grow at a slower rate. And that would be a cheap price to pay for lives that were less harried and where our relationships were more rewarding. I guess that’s what Gittinomics is driving at.
