An Economic Narrative

This is a first draft of a piece I am developing. Constructive criticism is welcome.

We need to tell a new story about the economy. I don’t mean a new theory. Alternative theories already exist. The old dominant framework for academic economics was fatally wounded in the crisis of 2007-8. It is dying slowly. As Thomas Kuhn argued a scientific revolution takes a generation and is only complete when the old professors have retired or otherwise moved on. What we need is a new narrative.

The narrative derived from the old idea still shapes our thinking, our policy-making and public discourse on the economy. The language we use to describe economic features is derived from the old story. If we want more informed discussion, more creative policy thinking, and better outcomes we need to break free from this old idea and put something better in its place.

The current narrative puts markets at the centre of all economic thought. Buying and selling in the marketplace, in this story, is the engine that drives an economy. There is a great deal more to an economy than markets. The old Labour Party constitution used to talk about “production, distribution and exchange”, but in recent years exchange has become the dominant force. Public discourse will only talk about goods, services, wages, profits, housing, technology and international trade in terms of markets.

My argument for a new narrative begins from a critique of how the market story distorts and limits our ability to frame alternatives. Firstly, markets are impersonal. They are set above us, above the level of human action. As Lady Thatcher once said, “you can’t buck the markets”. The market story serves to disempower us as workers, consumers and citizens. This narrative sets the economy as a thing apart from society, like a disembodied machine which runs on its own logic beyond human control. We cannot vote for economic change if it is the market that has the power.

For example, the market story justifies both low wages and obscenely high salaries. Care workers on precarious contracts with private suppliers are paid the rate for the job decided by the market. Even the national minimum wage was introduced in the teeth of opposition which claimed the market would punish the Labour government for its presumption. Meanwhile corporate CEOs are in a different labour market where international competition drives salaries and benefits ever higher. All wages in between are subject to market forces, unless the workers concerned have strong trade unions.

Up to a point, consumers do have power in the market story. If we want to improve the environment the market will provide organic produce and charge us a premium. To avoid exploitation the market will serve up fair trade foodstuffs. If climate change is a priority then the market will offer to offset our individual carbon footprint. However real change to protect the environment, promote development and tackle global heating require fundamental changes beyond any individual choices.

Secondly, the market story distorts our understanding of the economy. Its emphasis on the exchange of goods and services obscures the questions of where these goods and services have come from in the first place. Equally it offers no explanation for economic change. It does not account for technology and technical change. It appears that technology is also above the level of human action and springs fully formed from the head of Zeus to challenge the status quo.

At best the old narrative allows for “entrepreneurs” who bring innovations to the market. The role of research, development, regulation, social change, incremental advance, public sponsorship, spillover effects, market power and a host of other factors which contribute to innovation is not accounted for.

A major gap in the market story is that it fails to address the large part of the economy which does not operate on market mechanisms. About a fifth of the economy is accounted for by services paid for by the government rather than the final customer. The market story does not just ignore the production of these services but creates the impression that they lie outside the economy and need to be paid for by the market sector.

A further distortion arises from the way the market story denies the importance of market power, for example in the case of monopolies.  According to the narrative monopolies should not exist. Where they do it is a sign of market failure and the government should act to eliminate them. Unfortunately, the reality of the economy we live with is that market power is ubiquitous across the corporate sector. (More on this later.) As an MBA student I learned that the purpose of business strategy is to find and exploit opportunities for market power.

This leads to poor policy choices. For example, most utilities have a natural monopoly. In the past this was dealt with by nationalisation. However, when they were privatised competition was introduced through the creation of several supplier companies. This does not eliminate the basic economics of a natural monopoly and so the then governments created regulatory bodies with a mission to ensure that the new companies behaved as if they were in a competitive market. The experiment failed. The utilities have found ever more inventive means of exploiting their market power. This is evident from the wide range of prices gas and electricity firms offer their customers when, in theory, a competitive market has only one price.

From Theory to Story

The power of the market narrative came from the fact that it was derived from a highly developed economic theory which has dominated professional economics over the same period. Neo-classical economics has its origins in the late 19^th century. Economic thinkers created a model in which prices were determined by an equilibrium between supply and demand. In each market, they argued, there was a unique price which balances the number of buyers and the number of sellers.

This idea dominated micro-economics throughout the 20^th century. It had less success in macroeconomics where it was overshadowed by the ideas of J M Keynes. However, in the 1950s an important mathematical argument was expounded which showed that it was possible for all the markets which make up an entire economy could be simultaneously at equilibrium. In addition, it was claimed that this general equilibrium represented the best of all possible worlds.

In the 1970s Keynesian ideas began to lose out to the revival of neo-classical economics with the concept of general equilibrium providing a means for analysing the macroeconomy. The macroeconomic models which incorporated some of Keynes’s ideas (IS-LM and Mundell-Fleming, for example) gave way to new neo-classical models. The Treasury, the Bank of England and most academic economists now run “dynamic stochastic general equilibrium models” though their powerful computers.

For four decades we have lived with a dominant narrative of the economy which has now run its course. The idea that the economy could be understood in terms of markets gave us a story in which markets were the core of all economic function. It is a story which obscured a great many other truths. There is much more to economic life than can be understood from exchange in marketplaces. The old narrative separates the economy from its social context, setting it above or outside human control. It both disempowers and hides the reality of where economic power rests. It provides justifications for inequality, low wages and unemployment. It obscures the processes by which wealth is created and shared and undervalues the contribution from the production of public services. Finally, it fails to expose how economies change and develop. Technology, like the economy, isn’t something that happens it is something that we do.

We need a new narrative; one which shows how the economy is embedded in society and interacts with its social and political developments. It should have at its base the human activity that produces goods and services that make up the wants and needs of the community. The new story should recognise that we live in a rich country where there is surplus enough for everyone’s needs. Economies are in constant flux and our new story should combine understanding of the forces of change with the need for the social and political environment that makes a dynamic economy possible.

That is the challenge I set myself. In future posts I will ty to set out the narrative for a dynamic, production economy.