LOSING CONTROL (3 page)

Political economy has too often been ignored, its imprecision and normative nature incompatible with the extraordinarily complex mathematical models that form the bread and butter of the typical economist’s tools.
Yet, as the emerging nations stake their claim on the world’s scarce resources, the West’s influence on global economic affairs is on the wane.
How will scarce resources be distributed?
Will the market be left in charge or will nation states increasingly call the shots?
And is Western economic power beginning to fade?
The interaction between the Western world and the emerging nations brings the politics back into economics (and, for that matter, takes the mathematics out).

Market forces alone cannot deal with political economy.
Nevertheless, for many years, policymakers were happy to leave difficulties over scarcity to the market and, in particular, to the price mechanism.

It is easy to see why.
Since the end of the First World War, the political and economic debate both among and within the major powers has focused on the relative merits of market and state
as providers of our economic well-being.
Early in the twentieth century, the debate became increasingly polarized through the impact of the Russian Revolution in 1917, the strengthening of the trade-union movement in the UK in the 1920s and the US Great Depression of the 1930s.

The debate, in turn, reflected the search for an economic system that raised living standards for populations at large.
With the end of Maoist policies in China in the late 1970s and the collapse of Soviet communism at the end of the 1980s, it seemed as though the market had emerged triumphant (that, at least, became the myth: public sectors in the Western world nevertheless consumed a much greater proportion of resources than they did at the end of the nineteenth century).
Economic growth in North America, Europe, Japan, Australia and New Zealand (mostly the Western world) was faster, more sustainable and of better quality than under Chairman Mao’s China and the Soviet regimes of Russia and Eastern Europe (which, too often, relied on slave labour).
Eastern European countries became ‘client states’ of the Soviet Union, commanded to produce goods with no regard for the idiosyncratic economic advantages each country enjoyed.
This was economic policy by edict.
It was not a reflection of society’s true preferences.
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At the level of the very small, markets often work very well.
While we don’t pop down to the local supermarket and studiously calculate the opportunity costs of each of our purchases, opportunity cost is still involved.
Our budgets reflect scarce resources.
And the way we allocate those resources depends on price.
The price mechanism, in turn, is a remarkably efficient way of allowing us to make informed choices about scarcity.
If something is expensive, its opportunity cost may be high.
If something is cheap, its opportunity cost might be correspondingly low.
Adam Smith (1723–1790), one of the economic greats and now deservedly immortalized on the Bank of England £20 note, called the price mechanism the ‘invisible hand’.
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Many people have been seduced by Smith’s ideas, sufficiently so as to claim that free markets are the sole reason behind the West’s ongoing prosperity.
Yet markets do not always work very well.
They are not very good at identifying the environmental consequences of our actions.
They do not cope well when there is a lack of well-established property rights.
Why invest, for example, if your profits are siphoned off by an avaricious government or by a Mafia-style protection racket?
With insufficient information, markets cannot always deliver desirable outcomes.
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People too often try to rig markets for their personal gain.
Monopolies, for example, may not act in the public interest, but they can certainly make their shareholders very happy.
Markets do not always deal satisfactorily with choices over time.
Capital markets, for example, are supposed to say something about the preference for consuming now as opposed to consuming in the future.
Sub-prime crises, banking failures and equity market booms and busts suggest, though, that capital markets are not always entirely reliable.
With time comes both risk (which can be quantified to a degree) and uncertainty (which cannot).

Good government is a precondition for effective markets, because without government there is no legal system and, hence, an absence of property rights.
Governments may need to step in to ‘correct’ the perceived unfair distributional consequences of the billions of transactions that now occur in the global marketplace.
In the presence of market failures, governments may also feel obliged to act through state provision of resources (roads, police and defence, for example), through regulation and through taxation.
If the market cannot provide, the state will.
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We thus live in a world of mixed economies where the pluralism of markets is countered by state provision of countless goods and services and, separately, a legal and regulatory rulebook for markets and their participants.
Whether market or state, however, the same difficulties apply: how are choices to be made in a world of scarcity?
And how are those choices to be expressed in a world where markets are increasingly connected but where individual nations wish to preserve their sovereignty?

With scarce resources, there’s no particular reason why higher living standards should always be achievable, no matter how market-friendly an economy might be.
How, then, have some societies managed to perform what would seem to be a remarkable trick?
If resources are scarce, how have living standards consistently risen?
How has the curse of Thomas Malthus (1766–1834), author of
An Essay on the Principles of Population
(first published in 1798), been sidestepped?
Is Western progress really just the result of market forces?

Malthus’s arguments were, as far as I can tell, based on his view that labourers had voracious sexual appetites.
In his words, ‘in all societies, even those that are most vicious, the tendency to a virtuous attachment is so strong that there is a constant effort towards an increase of population.
This constant effort … tends to subject the lower classes of the society to distress and to prevent any great permanent amelioration of their condition.’
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In other words, the lower classes tended to produce offspring in such numbers that they’d remain, collectively, impoverished.
Even if there was an improvement in technology that allowed people to have better lifestyles, those lifestyles would improve only temporarily.
People with higher incomes would be tempted to have lots of children: the resulting population increase would place additional pressure on resources, increasing prices, lowering wages and pushing the population back to a life of subsistence.

Not surprisingly, others took exception to this provocative stance, and Malthus himself later admitted that perhaps he’d been a little
harsh (even though, to be fair, his arguments were a reasonably accurate description of economic progress for the vast bulk of human history).
In subsequent editions of his
Essay
, he accepted that people might abstain from sex, marry late or turn down the opportunity to have sex outside marriage (given the imminent arrival of the prudish Victorians, these observations were more accurate than he could possibly have imagined: Victoria became queen three years after Malthus’s death).
Oddly, he referred only to the lower classes.
Perhaps he thought the landed gentry either didn’t find each other attractive or, instead, were mostly homosexual.
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In the developed world, the Malthusian constraint has been overcome by human ingenuity, more specifically efficient economic organization, technical progress and contraception.
Over time, we have learnt how to create more and more outputs from given inputs, and we have also managed to control the unintended consequences of our lasciviousness.
That, at least, is the popular myth.

Long before Malthus’s provocative
Essay
, Adam Smith had already emphasized the division of labour with his famous example of a pin factory and the skills specializations of its various workers.
Through specialization, many more pins could be produced.
Combine specialization with technical progress and society can deliver huge improvements in living standards.
It’s called productivity growth.
Think, for example, of the first trains, planes and computers.
Each was a remarkable achievement, but each was the beginning, not the end, of an endeavour.
Stephenson’s
Rocket
doesn’t compare with Japan’s Shinkansen (or ‘Bullet’ train).
The Wright Brothers’ inaugural flights cannot compete with the Airbus A380.
The earliest mainframe computers had less processing power than the cheapest of today’s laptops.
In each case, innovations have led to enormous improvements in productivity.
Capitalism, meanwhile, rewards some of the risk-taking innovators with profits (it also, of course, creates losses for others).

This constant process of innovation is capitalism’s greatest strength.
Karl Marx (1818–1883) understood this very well.
Even though he implored the ‘workers of the world [to] unite: you have nothing to lose but your chains’,
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he nevertheless recognized that capitalism was a critical stage in man’s economic development: the revolution could only be a success if capitalists had created the wealth that could eventually be distributed among the proletariat.

Capitalism thrives best when ideas are allowed to flourish and where profitable opportunities can be developed.
Remove those key incentives and economies atrophy.
The success of the developed world partly rests, then, on freedom of expression and the rule of law (particularly with regard to the establishment of legally enforceable property rights, a point well understood by Adam Smith: the incentive to develop a new product is much reduced if there’s no patent system, for example).
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Meanwhile, contraception has limited population growth in the developed world and, hence, has allowed ever-increasing income to be shared out among the lucky few.
Ireland’s Celtic Tiger boom in the 1980s and 1990s was achieved in part because women were able to go out to work rather than staying at home to endure far too many births: contraception can also play a big role in creating economic opportunity.

As Sir Isaac Newton might have said, we benefit economically from standing on the shoulders of centuries of creative, inventive and innovative giants.
Each giant made his or her own contribution to the advancement of productivity.
Productivity – measured either as output per hour or output per head – is the elixir of economic growth, the magical process that seemingly bypasses the problem of scarce resources.
Productivity is, thus, the alchemy that turns base resources into economic gold.

There have been many interruptions along the way, including, most obviously, wars, the Great Depression of the 1930s and the
stagflation of the 1970s.
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Moreover, not all countries and continents have benefited from productivity’s magical effects.
While the developed world has become progressively richer over time, and the emerging world is now beginning to catch up, other countries and continents have suffered.

Some countries – notably in sub-Saharan Africa, parts of Central Asia and Central America – have been caught in seemingly irresolvable poverty traps.
In many of those countries, the Malthusian constraint does, to a degree, hold.
Parents choose to have many children not necessarily because, in Malthusian terms, they’re addicted to sex, but, instead, because having more children supposedly guarantees greater economic security in old age (particularly so if property rights are poorly established and, thus, financial savings can easily be lost).
Of course, if everyone thinks like this, the population multiplies too quickly and people, all too often, starve.

To remove the Malthusian constraint, then, any self-respecting political leader wants to have a piece of the productivity action.
Higher productivity should deliver higher incomes.
Yet, as I argue throughout this book, gains in productivity have not delivered universal benefits.
With the rise of the emerging nations, the economic calculus is changing in ways that seem to be undermining Western hopes of ever-rising living standards, even allowing for continued technological progress across the world as a whole.

The changing fortunes exemplified by Wimbledon and the Olympics stem from two key aspects of globalization.

Political barriers have come down.
Following the collapse of Soviet communism, estranged countries and their previously repressed people have become more closely connected with the Western world than before.
On the streets of London and New York, Russian accents
these days represent a combination of super-rich oligarchs and the new pioneering spirit from the East and not necessarily, as once might have been the case, the presence of the KGB.
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