Wednesday, November 8, 2023

25 economic orthodoxies that should be discarded

Angus Deaton has set the cat amongst the pigeons by writing a book lamenting the state of economics in America. He has written that economists have been unmoored from realities with their dogmatic attachment to theories that are based on markets and efficiency maximisation. He has a chapter that goes to the heart of the issue titled, "Is economic failure a failure of economics?". I look forward to reading it. 

In this backdrop, this post will point to twenty-five insights from the real world that demand a break from theoretical orthodoxy. This blog has covered all of them in different posts (though I've not linked to them here). 

1. Just as there are no frictionless surfaces, there are no free markets in this world, ones that have perfect competition. Nor can there ever be any such markets. All markets, embedded as they are in the real world with people having widely varying and idiosyncratic preferences, suffer from imperfections and failures. The markets cannot self-correct these. Policy interventions are essential in those markets where failures impose significant social costs. 

2. The untrammeled pursuit of efficiency should not be valorised. Efficiency trades off against other important factors like resilience, fairness, democracy, community, etc. It invariably results in the marginalisation of these factors. The desirable objective function on any public issue is dependent on all these factors. The pursuit of efficiency maximisation is the driving force of capitalism, and manifests mainly as profits maximisation for a handful while inflicting large social costs. These social costs generate political consequences that cannot be ignored. 

3. Trade produces powerful winners and powerless losers. The losers are also often diffused across the population. The adjustment costs are both prohibitive and long-drawn, if at all. And the winners are powerful enough to prevent any meaningful redistribution. This limits the case for theoretical trade liberalisation. 

4. There's no level playing field in international trade and trade liberalisation has gone too far that its aggregate costs have become prohibitive. A rebalancing is not only politically inevitable but also desirable. Instead of describing it as protectionism, a more appropriate framing would be the reversal of a trend that had gone too far for the public good. There's enough evidence from economic research by the likes of Dani Rodrik that tariff levels are well into the state of diminishing economic returns. As David Autor and others have shown, there's indeed a China effect that causes local suffering and discontent. 

5. Like with trade liberalisation, the pendulum on globalisation too has swung to an extreme. Business trends like outsourcing, off-shoring, and unbundling of value chains in pursuit of efficiency have reached a stage where their private transaction costs exceed their benefits, and where their social costs far exceed their private benefits. Besides, they pose resilience risks and create disturbing strategic concerns. There has to be a recalibration of globalisation.

6. As Dani Rodrik has described, global citizens are national shirkers. Immigration is not an unalloyed good. At a time when good jobs are getting scarcer, let's acknowledge that immigrants compete with locals for jobs. In this context, beyond a certain level of immigration, its aggregate benefits start to be outweighed by its localised (or concentrated among certain geographies or population groups) costs. At a social level, it has to be recognised that immigration beyond a certain level strains communities. Opinion makers and academic scholars cannot wish away the real-world pressures faced by politicians due to immigration. 

7. The agenda of capital account convertibility must be replaced with capital flow management (aka capital controls), especially for developing countries. Financial market deregulation has gone so far that private benefits far exceed its social costs. Global financial markets suffer from the problem of recurrent cycles of capital flows and sudden stops that destabilise and devastate whole economies. Finance loses its disciplining powers in good times and engenders irrational exuberance which in turn inflates bubbles. 

8. Marginal tax rates should be increased to account for the extraordinary growth in wealth and incomes at the top percentile or so. High marginal taxes have been the norm for much of the last century and during the entire period in the fifties and sixties of the longest-ever post-war economic expansion and broad-based prosperity. Besides, there's nothing to suggest that people will reduce effort and investment if marginal tax rates are raised. 

9. The preferential treatment given to capital gains should be eliminated. It has distorted financial intermediation and created a world where capital gains are the major source of wealth creation globally. It also amplifies the pre-existing biases towards capital (and against labour) and ends up creating a self-reinforcing spiral of ever-widening inequality. 

10. The tax deduction on interest expenses should be restricted to a certain upper limit, beyond which it should be taxed. There's a market failure in the provisioning of capital when firms with the largest cash reserves leverage up and undertake share buybacks. The largest firms and those too big to fail enjoy an implicit market subsidy in their cost of capital. Besides, it distorts the capital allocation process by encouraging firms to leverage up excessively. 

11. Governments should not shy away from imposing windfall taxes when it's clear that the companies did nothing to earn their out-sized profits. Mining and oil companies at times of geo-political tensions, financial institutions in times of extraordinary monetary accommodation, and shipping companies during the recent pandemic lockdowns are examples. Windfall profits are an unearned increment. They are acts of God. Just as companies rush to governments seeking bailouts when faced with negative shocks, it's only natural that windfall profits be socialised.

12. It's a reality that tax arbitrage and avoidance are pervasive among multinational corporations. They incorporate entities in tax havens and transfer profits to them. They also create shell companies and exploit tax arbitrage opportunities like Double Irish with a Dutch Sandwich to minimise their tax outgo. In the globalised world Corporate tax arbitrage Tax havens, off-shore and on-shore, are a negative externality on the world economy. They are a good example of beggar-thy-neighbor policy. Such tax base erosion by profit shifting should be curtailed if not eliminated. 

13. Financial markets have come to assume a disproportionate share of the economy and corporate profits. It's already a magnet that crowds out talent from other important economic sectors like manufacturing. Businesses tend to find financial market opportunities and revenue streams more attractive than their core businesses. Financial structures and instruments that raise capital by converting private risks into systemic risks whose costs have to be borne by taxpayers should be strictly regulated. These are all market failures. How much financialisation is too much?

14. There should be deep reform of the institutional plumbing of global financial markets. These should include credit rating agencies, auditing and accounting firms, and international arbitration systems. Instead of being gatekeepers and intermediaries to ensure the effective functioning of the financial markets, they have been captured by vested interests.

15. Fraudulent practices, especially in financial, legal, and consulting services should attract criminal liabilities. No senior Wall Street executive went to jail in the US for having brought the economy to its knees with their financial engineering. Executives and employees of firms in these industries currently pursue such practices, having internalised the belief that if detected they'll get away with a slap on the wrist and (relatively) small financial penalties. They have internalised these penalties as the cost of doing business. 

16. There should be limits to executive compensation, one that's benchmarked to the median salary of the corporation's employees. There's no evidence to suggest that the spectacular salaries that many chief executives pay themselves generate anything close to value for money, nor is there anything to suggest that these executives will stop working and putting in their best efforts if all their salaries come down by a few orders of magnitude.

17. The regulatory arbitrage enjoyed by technology platform companies over their brick-and-mortar counterparts should be eliminated. Now that these platforms have grown into dominant and well-established companies, and the social costs from their arbitrage are prohibitive, it's time to level the playing field. It's time to end the delusion of being contractors and not employers, content providers and not publishers, private carriers and not common carriers, and being marketplaces without any responsibilities.

18. Data is today's oil, and there's a deep failure in the market for data. Consumer data (specifically the digital trails left behind by consumers on their platforms) is a free feast for large Tech companies. In a perversion of property rights, the rightful owners of those digital trails are not only deprived of their property rights but also do not get any compensation for their commercial exploitation by Big Tech. Entire lucrative business models and massive revenue lines have emerged from these digital trails that have enriched corporations while its generators are, at best, left with deeply discounted crumbs in the form of conveniences and addictive pleasures.

19. Technological choices have to be collective socio-political choices and cannot be left to the whims and fancies of a few large corporations and individuals. Left to the incentives of commercial interests, technological evolution will be determined purely by considerations of revenue expansion and profit maximisation. The examples of Social Media and Artificial Intelligence (AI) illustrate that a purely commercially driven direction may pose existential challenges to human society. As Daron Acemoglu and Simon Johnson have shown in their book Power and Progress, historically there's nothing automatic about the trajectory of technologies. Those trajectories are conscious social and political choices. 

20. Automation is already looming as an existential threat to humanity. Where will the jobs to absorb the expanding global population come from? How much automation is too much? In these circumstances, the adoption of technologies like driverless cars should not be left to the commercial considerations of the market. Similarly, in developing countries with an abundance of cheap labour, industrial promotion policies should step back from supporting capital-intensive industries towards labour-intensive ones. 

21. The practice of contracting labour and outsourcing services has gone too far. Businesses now see contract hiring and outsourced labour services as a cost minimisation strategy. But such labour market practices impose externalities by forcing society to bear the costs like the provision of social security. It's the exact opposite of what Henry Ford did in the early part of the twentieth century in creating good jobs that support mutually beneficial self-reinforcing economic growth. At a time when technology and the dynamics of capitalism threaten to shrink the pool of good jobs, it's important that firms be prevented from exploiting regulations to exacerbate the problem. 

22. The scope of anti-trust actions should expand beyond mere consumer welfare to include anti-competitive practices, technology, and business models that are likely to cause future harm and business concentration. There are now too many examples from the business practices of Big Tech companies to incontrovertibly demonstrate their intentions to do whatever it takes to kill off any emerging competition and retain their now deeply entrenched market power. The world of network effects and high entry barriers demands a revision of the prevailing narrowly conceived anti-trust paradigm. 

23. In the world of too big to fail (TBTF), there's a compelling case for putting limits on how large a company can become in any industry. It'll be very hard in practice to determine what's a threshold for TBTF. However, market regulators and policymakers should keep this in mind while designing and implementing policies. Apart from the market power exercised by dominant corporations, they also end up capturing the political process that formulates the rules of the game. It destroys the social compact and corrodes democracy itself. Very early Adam Smith recognised this potential for market abuse and political capture.

24. The patent protection regime should undergo change to prevent abusive and restrictive practices. Patents, especially in the pharmaceutical industry, have become a high-stakes rent-extraction system. There's little to suggest that this degree of protection is required to sustain innovation nor that without it the incentives for innovation would be significantly blunted. 

25. Lack of affordable housing is already perhaps the biggest threat to urban growth, especially in developing country cities. Affordable housing requires a combination of orthodox policies like easing zoning restrictions and also policies like public housing construction and, in some cities, appropriately calibrated rent controls even if for short periods of time. It's also required to disincentivize the practice of buying residential property purely as an investment by increasing its cost (of such purchases and holding them) with tax and other policies. 

I'll also list three general principles that should inform public discourses on issues of public interest.

1. We live in the real world with its social constraints, messy politics, scarce resources, and weak institutional capabilities. These means that reality deviates considerably from theory and logic, and this cannot be wished away. Policy prescriptions and ideas should therefore take into account these realities. Advocating policies that deviate from realities is at best ignorance, and at worst, misleading. 

2. Related to this is the insight that the solutions to complex and intractable public policy problems are rarely technocratic in nature. They require combining the smartness of technical expertise with more importantly the wisdom of experience. The former without the latter is most often misleading or plain wrong. But experience is gained through an immersive and accretive process and its acquisition cannot be short-circuited or learned in a classroom setting. 

Effective solutions emerge from the exercise of good judgment that combines technical expertise with experiential knowledge. The ancient Greeks had a word for this, phronesis, the wisdom relevant to practical action. Technical experts rarely have the experiential knowledge to be able to exercise good judgment on complex issues. In order to bring accountability, the credibility of technical experts should be determined based on how their career prophecies held up when faced with realities. 

3. The essence of equilibrium in any system is balance. The Greeks had a word for this, meson, or the middle. Unfortunately, the innate dynamic of most phenomena generates a gravitation or swing to the extreme. This is just as true of social systems as it is of physical systems. Any trend - capitalism, socialism, statism, globalisation, liberalisation, privatisation, deregulation, financialisation, automation, etc - if left to itself follows a self-reinforcing feedback loop that ends up destroying countervailing forces and creates its excesses. There's therefore the need to consciously create or encourage countervailing forces to achieve a dialectical balance.

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