It appears from reading several articles in Australian Humanist that there is sometimes a degree of alarm and anxiety concerning economic issues. The views expressed often imply that economists are concerned only with money and neglect the human factor, the environment, resource depletion and wrongfully promote economic growth, which is seen as implicitly damaging. A similar debate has occurred between scientists and economists over Australia’s population. As some of these views may involve certain misconceptions about economics, it may be helpful to offer a few comments of clarification on the "dismal science".
In fact, the concerns of humanists and those of economists often coincide. In a broad sense, economics can be described as the study of collective human behaviour and human welfare in relation to the real world. To accomplish this study however, economists value things in terms of money. This is because qualitative measures are insufficient and quantitative measures are required for comparison purposes. It has been said that all of economics can be reduced to an index number problem – for example that of maximizing a community welfare index constructed from all relevant measures. Problems arise in this endeavour in deciding what items to include in such a welfare index, what weights are given to each item, and how to objectively value intangible things that may be relevant to welfare. In practice, because of these difficulties, and with reservations, economists use Gross Domestic Product as an indicator of aggregate welfare.
GDP is by construction equal to National Income – the value of all goods services bought in the domestic economy equals the value of those sold. As well as company income, all personal income is included. It is in this income sense, that GDP is related to national welfare. Many things such as environmental damage, e.g. land salination, are not included in GDP. However any expenditure on fixing such salination would be included. More general welfare measures have been attempted, by for example deducting the value of land degradation and including valuations of intangibles. The problem is that where no transaction has taken place, there is no objective way to measure the value of such things. So, although inadequate, GDP is used as a proxy for human welfare in economics.
That economics is unconcerned about depletion of scarce resources is a charge that economists may find surprising. Standard textbooks open with the description of the realm of economics as dealing with the three great issues regarding the allocation of scarce resources: what to produce from them, how, and to whom the benefits are distributed. The textbooks in microeconomics then continue with a "neo-classical" mathematical representation of the original works of Adam Smith and David Ricardo. In general this contends that individual behaviour, motivated by self-interest, by lucky default, also provides an outcome that is good for communal welfare, due to the workings of natural market forces.
Market forces work by way of the market price, which provides a universal information transmission mechanism. Consumers respond to it. Producers respond to it. If the price goes up, people buy less, producers make more, and vice versa - supply and demand. This is not mere conjecture, it is a law of human behaviour not unlike any natural law, with wide, but not universal, application. The market price is a natural stabilizer. Attempts to replace it by alternatives such as central planning, as in the Soviet Union, fail because the task is too immense.
Goods and services are traded, between individuals and between countries, because both parties benefit. Specialization in areas of comparative advantage leads to greater efficiencies – less wasteful use of resources. Competition between producers leads to efficient production. This is based on the idea that in production, there is an optimum level. If a firm produces too little, it will not be able to make proper use of its machinery, workers etc. If it gets too big it will become bureaucratic, its costs will increase, reducing profit rates. Competition leads to a result that is best for society - producing the quantity that consumers want with the minimum use of resources at the lowest price. That is the theory anyway.
Because of economies of large-scale operation, there are certain industries that are natural monopolies. Whether these should be publicly or privately owned is still contentious. What is not seriously in contention anywhere any more is that "market forces" in general, and with safeguards, work in the public interest and not against the public interest. While there are certain provisos, caveats, special considerations where market forces may require legal regulation, there is a element of truth in the contention that market forces are beneficial to the human condition that is undeniable. Attempts to deny it will meet the same reaction from economists that scientists might have to creationist arguments and with equally valid reason.
Contrary to what some may contend, this does not mean that the governments have no role in economic management and should abdicate all responsibility. Apart from trying to ensure micro efficiency, there is a duty of macro economic management of the national economy. This means using fiscal means e.g. tax rates, interest rates etc, to try to obtain desirable outcomes for unemployment, inflation and other objectives. Keynesian economics is now less fashionable but still relevant. It generally means that governments may run a budget deficit in recessions and a surplus otherwise – i.e. providing counter-cyclical stablization. Recent experience shows it should be done more restrictively in times of inflation. The trade deficit (different from the budget deficit) and the level of foreign debt historically were also issues of concern of governments - until the current one in Australia. Consequently our exchange rate will likely continue a long-term drift downward.
With that brief outline of what economics is concerned about, it might be useful to consider why economists and scientists may have such different world-views. Possibly this is because in science there are many immutable laws such as conservation of mass and of energy, and in biological systems, the concept of exponential growth seems incompatible with ecological balance. What is perhaps most counter-intuitive to scientists is that economic growth is both desirable and sustainable.
The reason for this is the increased productivity provided by technology, something that was overlooked by Malthus, Marx, and is still overlooked by contemporary scientists. Productivity measures the amount of something produced for given quantity of inputs of labour, materials or equipment. On average of this has been rising at around 1-2% per year ever since the industrial revolution. This constant percentage rate of change has provided an exponential increase in productivity, enabling higher real wages and higher standards of living over time. There is no sign of technical progress slowing down. If anything, it seems to be accelerating. Over the whole economy, long term technical progress provides higher average output per unit of material input. As a result most commodity prices are in long term decline.
GDP is a measure of the total production (and income) produced in the economy. What is commonly meant by economic growth is this measure after allowing for inflation (real growth). A higher value is seen as desirable partly because unless it exceeds population growth by about 2%, employment will fall due to productivity growth. Economic growth after adjusting for population growth is measured by real per-capita GDP growth. Looking at this value over a long historical period, it averages a positive 1-2% per annum. This means that for the same number of people we always manage on average to produce more each year. This arises because of better production techniques, more efficient use of resources and of technical progress.
The underlying cause of per capita GDP growth, or increased standard of living, is the application of scientific research and development and innovation in society. It is the fruit of scientific method. Scientists would be perverse to be opposed to the fruit of their own labour. In general, environmental degradation is not caused by increased population but by poor environmental policy that allows such degradation to occur. Economic growth provides an annual dividend that may be used for environmental issues. That however, may require higher taxation, which as a political matter, is problematical.
What makes a lot of economic issues difficult to grasp is that because of the circular nature of the economy, there may costs and benefits, winners and losers, not all of which may be immediately obvious. Further, a lot of economic views have an implicit but unexpressed political bias. Economics is not a science where experimental method can be applied. Statistical inference can be used for empirical investigation but the results are often inconclusive. As a discipline, economics based on scientific method and is certainly not opposed to humanist ideals. On the contrary, economics can throw important light on issues of human progress of concern to humanists.
This article was originally published in Australian
Humanist, No.69, Autumn 2003.
(C) Copyright 2003 John L Perkins