One of the most glaring omissions from modern economics is the complete absence of any mention of power. Textbooks describe a world where everyone is equal and no one has power to influence others to benefit themselves. Norbert Haring and Niall Douglas make a huge contribution to correcting this omission by discussing the importance of power relations in economics and during the financial crash in their brilliant book, Economists And The Powerful. They show how power got removed from the economics discourse for ideological reasons, the power and influence of the financial industry, the corporate elite, how the economy is best described as monopolistic competition, how the money supply is controlled by banks, how the labour force is shaped by market power and how the government is manipulated by corporate interests for their own gain. It is a superb book that I highly recommend.
They open with a discussion of how power got removed from economic theory and replaced with an ideology more compatible with the free markets. Power was originally recognised as important by the Classical economists like Adam Smith. However this changed with the rise of socialism. Wealthy industrialists and rulers feared this threat and sought to find an economic theory that would debunk socialism and protect themselves. It was for this reason that economics began to downplay issues like inequality and poverty. It also de-emphasised production and therefore any resulting questions about social relations. Instead economics switched to discussing marginal utility of hypothetical individuals where none had power over the other. There was no boss or servant, but rather groups of individuals voluntarily interacting in mutually beneficial arrangements.
Crucially, economics became depersonalised and it was no longer possible to make value judgements. A dollar spent by a rich person on a loaf of bread was the same as a dollar spent by a poor person on the same loaf. It was no longer argued that one person may need the dollar more or that the starving may need the loaf more than the fat. Economics abandoned the idea that people have needs and assumed we only have desires.
This change in focus did not happen by chance or due to superior argument but due to the politics of the time. During the Cold War there was a major ideological battle as America sought to prove that the free market was superior to communism. In this they drafted the economics profession to help. Economists focused on praising the free market while attempts to praise government intervention were frowned upon. This was at its most blatant during the McCarthy era where any criticism of the free market was considered a sign of communist sympathy. Even when open intimidation was not used a more subtle form was. The main economic journals and universities were dominated by the neo-classical school of thought and the only way to get published or receive grants was to go along with the theory whatever its faults. The main example of this was the Research and Development Corporation (RAND) an institution that gave grants to economists willing to be used a Cold War weapon. To give an idea of its influence, 32 winners of the Economics Nobel Memorial Prize have been involved or associated with RAND. In a case of he who pays the piper calls the tune, the economics profession in America has become swayed by the fact that its main sponsors are corporations and wealthy individuals who would not look kindly on criticism of their wealth.
Haring and Douglas pay particular attention to the power of the financial industry. This comes from the fact they are many people who want to borrow but few who want to lend. They also have huge power as they have control over depositor’s money. As banks deal with a wide variety of assets and businesses they have access to a large amount of insider information. These conflicts of interest are rampant in the industry and almost never punished. Banks also influence supposedly independent brokers leading to investments that benefit the banks more than the clients. Pension funds are regularly manipulated to benefit the company’s share price and charged high administrative costs. Due to the large economies of scale, the financial industry is an oligopoly with a handful of large firms. This is because size is security and larger banks have more reserves than smaller ones. Also banking is based on trust which takes years to build. Hedge funds in particular are bad for exploiting insider information to profit from economic turmoil; it has been found that hedge funds profits are highest when the market is in most distress.
What I found particularly interesting and novel in the book was the discussion of central banks and the control of money, a topic usually discussed only by Austrian economists and Ron Paul and in fact they regularly reference Murray Rothbard. Haring and Douglas argue that the right to create money does not lie with the government as we all assume, but with banks. By giving out loans, banks increase the money supply, usually by a far greater amount that the government printing press. What I found particularly insightful was that when banks create money, they keep the profit. So if banks keep a 10% reserve rate, a deposit of $10 is lent out as $100, with the bank keeping the profit from the $90 it has created. They view the Federal Reserve as a cartel of banking interests and criticise economists for pushing for central bank independence from government but not from banks.
Haring and Douglas argue that the government should nationalise the creation of money so that they profit from the creation of money (which lessen the need for taxes). Banks would be required to have a 100% reserve ratio, in other words they would only be able to lend out as much as they had in deposits. There would be a large increase in the money supply to replace the restriction of credit. Banking would be more stable and less profitable and would no longer carry the risk of collapsing the economy or being too big to fail.
Haring and Douglas point out the flaws in the neo-classical view of the economy, primarily the pretence that no business has market power. To do this they pretend things like profit, transport costs, information costs, differentiated products and economies of scale don’t exist. Of course this is contrary to what every business person knows. They are well aware that the location of a business can make or break it, that consumers have limited information, the importance of differentiating your product from your rivals and that the only limit on sales is demand, not increasing costs. All of these give a business a degree of market power. Within a certain radius competition is limited and the business can charge a higher price. This is known as monopolistic competition.
Empirically, it is much more accurate than perfect competition and draws very different conclusions. Firstly, it explains how inefficient firms can stay in business, something any free marketer denies as impossible. Studies how found wide variance in efficiency across all industries; on average the most efficient firms are twice as efficient as the least. Secondly it explains why there are so few firms in most industries. A new business must overcome initial fixed costs, unknown brand name and poor location to have a hope of being successful. Even still established businesses may cut prices and drive them out of business.
Monopoly isn’t always bad, as if firms were not earning large profits they would not be able to invest in innovation. Likewise if there are economies of scale, the introduction of new firms to the market could result in higher prices. However, monopolies tend to get lazy and bureaucratic. Without any threat of competition, they stagnate and cover their inefficiency by exploiting consumers or workers. Therefore monopolies are not wanted where dynamism and innovation is important, like the IT sector. However, where innovation isn’t as crucial but fixed costs are very high, like utilities or insurance, having a monopoly leads to lower costs.
The labour market too is a state of monopolistic competition. What neo-classical economics ignores is that people are not the same as goods, nor are they willing to be treated as such. While the good stays the same if its price is cut, cutting a person’s wage creates resentment and anxiety and makes them work less well. If workers feel they are treated like cattle or objects, they will work poorly and even sabotage their work. A business is not simply an inanimate combination of capital and labour, but rather an ongoing human relationship. It is not possible for an employer to watch their staff every moment of the day or ensure they don’t leave, just as the staff cannot always be sure the employer will keep them. Both sides suffer from limited information that cannot all be specified in a contract.
To get around this a relationship based on trust is formed. This is an unspoken agreement that workers will be kept employed as long as they do their job. Their wages will not be cut and they will not slack off. They will be protected from market forces to an extent. This is contrary to the neo-classical view which argues that wages should be cut and staff fired during hard times. However, employers rarely do this (the current recession was the first time in decades) as it would breach the trust with their staff. Workers don’t want to be seen as expendable or merely an expense. Employers avoid this for fear they screw the business over in return.
Textbooks assume that all unemployment is voluntary or caused by the government. They state that the unemployed should be allowed to work for a lower wage. However, this will not eliminate unemployment because employers won’t let it (or so Haring and Douglas write). This is because they protect their employees’ wages as part of their relationship. Were they to cut wages or hire low wage workers alongside them, this would decrease morale. Likewise the textbook statement that jobs with bad conditions have higher pay is also not true. Employers have good working conditions for the same reason they have good pay. Dangerous and dirty jobs are usually poor paying.
It is commonly stated that the government should not regulate work, that employers and employees can negotiate it themselves. If an employer offers unsatisfactory arrangements, the potential employee will go elsewhere. However, in reality this would never happen due to fear of adverse selection. For example, imagine you are interviewing someone who wants to know if you provide a generous healthcare plan. You first thought is that they may have some secret illness, so just to be safe, you don’t hire them. Likewise, if someone asks how generous are the breaks you provide, you will fear the danger of hiring a lazy slacker. Therefore all employees will pretend to be more enthusiastic and healthier than they really are and end up working longer and in worse conditions than is optimal. The solution is for the government or unions to level the playing field by mandating all businesses to provide healthcare and breaks.
Haring and Douglas spend a further chapter discussing the power of the corporate elite and their ability to influence politics, but this blog has gone on too long (as a rule I don’t write anything longer than 2,000 words and try to stick between 1,000-1,500). Suffice to say that Economists And The Powerful is a fantastic book that I highly recommend. It does a valuable service by highlighting the importance of power in economics a topic that is woefully ignored. It is a marvellous step forward and I hope more will follow it.