Friday, February 8, 2008

The ghost of Karl Marx is back!

Brad DeLong follows Martin Wolf, in highlighting a crisis of confidence facing the system of capitalist market economy.

Martin Wolf writes that the crisis engulfing the financial markets and the huge rewards generated for the beneficiaries is calling into question "the political legitimacy of the market economy itself". Calling for greater regulation of teh financial markets, he argues that "just as war is too important to be left to generals, banking is too important to be left to bankers, however much one may like them."

Highlighting the failure of the two central arguements of free market orthodoxy - a technologically advancing industrial society produces "positive sum economic games" that benefit everyone; and democratic governments balance market failures by social insurance, education, progressive taxation, and investments in people and community assets - Brad DeLong claims that the old Marxian prophecy of inequitable distribution of wealth, looms large.

He also points to the dilemma facing democratically elected governments, "Social-democratic governments have been on the defensive against those who claim that redistributing wealth exacts too high a cost on economic growth, and unable to convince voters to fund yet another massive expansion of higher education... And increasing rewards for those at the increasingly sharp peak of the income distribution have not called forth enough enterprising market competition to erode that peak. The consequence has been a loss of morale among those of us who trusted market forces and social-democratic governments to prove Marx wrong about income distribution in the long run – and a search for new and different tools of economic management."

In a brilliant article, Dani Rodrik calls to question the obsession with the best practices/institutions/processes ("one economics") that creates blind spots and leads us to overlook reforms that might achieve the desired ends at lower cost. He explores the world of second-best, third-best and other alternative approaches to solving the numerous challenges facing global economies. In his new book, One Economics, Many Recipes: Globalization, Institutions, and Economic Growth, he argues that countries develop successfully by following eclectic policies tailored to specific local conditions rather than by following generic best-practice formulas designed by economic theorists.

It is useful to quote him in some detail, "But real-world reformers operate in a second-best environment of their own, which means they need to keep an eye on how proposed solutions affect multiple distortions. Sometimes binding constraints will lie elsewhere and they need to guard against adverse interactions with other distorted margins. At other times, there will be multiple ways of removing a constraint, some of which may be politically much more feasible than others. Finally, the nature of the binding constraint will change over time, requiring a change in focus as well. Best-practice institutions are, almost by definition, non-contextual and do not take account these complications. Insofar as they narrow rather than expand the menu of institutional choices available to reformers, they serve the cause badly."

Dani Rodrik has this advise to policymakers is to "be strategic, rather than comprehensive. They have to do the best with what they have instead of wishing they could transform their society wholesale. They need to identify priorities and opportunities, and work on them. They must seek sequential, cumulative change rather than a single, all-inclusive breakthrough." He excoriates the multi-lateral development institutions like the World Bank, WTO and IMF "as international bureaucracies with a penchant for “best practices” and common standards, and woefully unsuited to the task of seeking innovative, unique pathways suited to each country’s particular circumstances."

He gives examples of the many recipes argument, "Successful countries do share some common features. They all provide some degree of effective property rights protection and contract enforcement, maintain macroeconomic stability, seek to integrate into the world economy, and ensure an appropriate environment for productive diversification and innovation. But how these ends are achieved differs. For example, greater integration with world markets can be achieved via export subsidies (South Korea), export-processing zones (Malaysia), investment incentives for multinational enterprises (Singapore), special economic zones (China), regional free trade agreements (Mexico), or import liberalization (Chile)."

His description of reforms is illuminating, "The best-designed policies are always contingent on local conditions, making use of pre-existing advantages and seeking to overcome domestic constraints. That is why successful reforms often do not travel well. Reforms, after all, are not hothouse plants that can be transplanted at will in any soil."

Thomas Palley has an concise, but broad sweep of the changing face of neo-classical economics. He contrasts the beliefs of the two schools of neo-classical economics - "Chicago School" (pioneered by Milton Friedman and George Stigler), who argue that real-world market economies approximate perfect competition, and the "MIT school" (Paul Samuelson, and his latest line of followers like Rodrik, Krugman, Stiglitz etc) who reject the aforementioned line of thought.

Palley writes, "The Chicago School claims that real-world market economies produce roughly efficient (so-called “Pareto optimal”) outcomes on which public policy cannot improve. Thus, any state intervention in the economy must make someone worse off. The MIT School, by contrast, argues that real-world economies are afflicted by pervasive market failures, including imperfect competition and monopoly, externalities associated with problems like pollution, and an inability to supply public goods such as street lighting or national defense. Consequently, policy interventions that address market failures – as well as widespread information imperfections and the non-existence of many needed markets – can make everyone better off."

Both however do not address the issue of fairness of outcomes. Chicago economists while acknowledging that real world outcomes are inherently unfair, (though acceptably unfair) reject any intervention to remedy this as unacceptably costly and causing economic inefficiency. They feel that any government intervention will fail because of bureacratic incompetence and rent seeking, which will lead to bureaucratic capture by vested interests. The MIT economists, while not explicitly calling for fairness in outcomes, approve of fairness and government intervention through good institutional design, including democracy.

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