Checks and Balances For the Field of Economics

Last time, in  Political Economy: An Old System for a New Day we looked at how much the world has changed since the times when the United States of America was founded and Adam Smith, the Scottish economists published his classic study of political economy, called The Wealth of Nations.

This time (and in the next couple of posts), we’ll be see how the notion of checks and balances from the US Constitution applied to economics is one way of bridging the gap between politics and economics today.

We’ll start by looking at how economics differs from the study of political economy in the 16th through 19th centuries. We’ll see why the field of political economy changed its name to economics at the end of the 19th century. This was throwing out the baby with the bathwater! We now need to go back and rejoin politics with economics. Read on to see why.

A system of checks and balances for a “political economy”

British economist, Martin Wolf, is fond of saying often in the London Financial Times that the nation of Germany has such a successful economy right now because it is a “surplus” country. The wealth of Germany Wolf thinks, exists only because other countries are poor. There has to be a balance he says. Surplus countries have to lose so debtor and deficit countries can gain.

This kind of “scarcity mentality” was fostered in the mid-20th century by professor Paul Samuelson’s “guns vs. butter” parable of how the economy “works”. Samuelson’s famous dictum resulted from WWII when citizens of the UK and the US literally had to make such an extreme choice between civilian and military goods. But that was over a half century ago. Scarcity mentality now is a bugaboo of a bye-gone age.

It’s also what the field of economics gets for splitting itself in two at the end of the 19th century. i.e., into microeconomics versus macroeconomics.

Alfred Marshall, the “father of microeconomics,” led his colleagues in creating this split after the political economists of that age reacted with fear and rage against an upstart German philosopher who literally laid to rest their field of study, i.e., political economy, with his critique of it in 1887 in his famous book, Das Kapital.

During the great depression of the 1930s, a British economist, Lord Keynes, a student of Alfred Marshall at Cambridge University, founded the field of “macroeconomics”. This is the subfield of economics that aimed to give control of national finance over to the hands of professional “economists”.

This movement too came out of a place of fear and loathing of Karl Marx’s prediction that capitalism would result in too much capital landing in the hands of the rich, while the poor became poorer and poorer, a scenario that was being played out on the streets of England, America, and elsewhere back then.

While the liberal British “neoclassical” economists attempted to remove politics from economics by turning economics into a precise mathematical science, the conservative European “Austrian school” of economists attempted to remove economics from the political arena by replacing Adam Smith’s mystical notion of the invisible hand (of god) with the idea that “prices” set by a “free market” would take care of creating “equilibrium” (balance) in a national economy.

Austrian school libertarians in the US in the 20th century, in contrast to the Keynesians, adopted the 19th century notions of individualism advocated by British philosophers like Jeremy Bentham and John Stuart Mill in England. They combined this individualism with Frenchman, Jean Baptiste Say’s “Law” written in 1800. This “law” of political economy  dictated that “supply creates its own demand”. Say’s Law is the predecessor of both supply-side “Reaganomics” and of the new Republican ‘fixe idea’ about “job creators” as the source of national wealth.

The Austrian School used Say’s Law to bolster its belief that “if you build it they will come”. The Austrian School (Hayek, von Mises, etc) feels that “there can never be sustained “overproduction” [predicted by Karl Marx] or underconsumption [i.e., the neoclassical economists’ “lack-of-demand” explanation of recessions] in the free market if prices are allowed to adjust.”

Price is supposedly determined by the intersection of aggregate (total) supply and demand. But we now have “supply-side” Austrian economics in an outright war with “demand-side” Keynesian economics within our national and state governments. In short politics is right back in the thick of economics. We’ve arrived too at a point where Martin Wolf’s lament that surplus must shrink if national deficits to diminish is being applied on the individual level too. Allegations of “class war” show that economics has come full circle. Economics is right smack back into the center of political economy as we argue over whether the pockets of the rich must be emptied via taxation for the pockets of the poor to be refilled.

All this illustrates why throwing out the baby with the bathwater back in the late 19th and early 20th centuries when Professor Marshall and his prize student John Maynard Keynes sought to slough off the label of political economy through splitting modern economics in two wasn’t such a good thing.

The truth about scarcity is that pies may need to be split into a fixed number of pieces in the short-run, but in the long run anyone can bake more pies. Only the limits of our own survival set bounds on the things that human beings are capable of imagining and making reality. As the poet put it:

“Ah, but a man’s reach should exceed his grasp, or what’s a heaven for?” (Robert Browning)

Germany’s successful system of corporate checks and balances

I disagree strongly with Martin Wolf on his way of viewing the crisis in Europe. I believe that Germany is ahead of the other countries in the Eurozone not because it has a trade surplus on the macroeconomic level, but because on the microeconomic level Germany has a system of corporate checks and balances that actually works.

Ever since the industrial revolution began in the mid-1800s those who owned and managed corporations in England and the US have tried to eliminate the ability of their employees to unite. The relationship between unions and management in this country has been completely antagonistic and hostile. At times its been like a civil war.

Germany, the country that the US bailed out because it was in shambles after it lost World War II, took a different path – over time the Germans have given workers more of a say in the management decisions that most affect those employees.

For example, just this week the Volkswagen Corporation and its union agreed to shut off the server that routes phone calls to worker’s Blackberries one-half hour before its employees left work for the day. Workers in Germany are no longer “on call” all hours of the day and night.

Employees in Germany belong to strong unions and they elect representatives who sit on corporate management committees and help to make real decisions of real importance. For example, when a company has to downsize, its workers get to help decide how to handle that – by job sharing, cutting their own hours, or other means.

US law would prohibit this from ever happening here. American workers will have to answer their cellphones 24/7 if that’s what a corporation wants.

Unfortunately, the Anglo-American scholars like Wolf, who dominate the current world of Western economics can’t seem to  see that what happens on the microeconomic (local and regional) level can seriously affect what happens on the macroeconomic (national/global) level. Liberal economists don’t even see the problem with gutting unions and not replacing those unions with any other checks on management. And neither do supply-side Austrian school economists.

Certainly we no longer have the checks and balances that were supposed to keep corporations under control. Government has been usurped by corporate payoffs. Shareholders these days can’t seem to cut down on the obscene bonuses upper management is awarding to itself or even wring more dividends out of big corporations. Consumers have little power over corporations either, since even a consumer protection agency created by the federal government cannot get itself off the ground.

German corporations are by no means democratic – far from it. But they do have the muscle to put a lid on unearned, extravagant, hurtful bonuses paid to corporate executives. That is why we need to bring back word “political” and connect it with the word “economics” again.

We need an overarching narrative that will splice together a splintered economics with a debilitated politics and make the two work together again. That is why we need to think about applying the political principle of “checks and balances” to the sphere of big business. This is why we need to restore the field of “political economy”and start over again.

Next time: Why The “Job Creators” Are Failing

Follow Nancy Humphreys on Twitter @brucenomics