Economics must tackle blind spots

The following comment by me appeared in the latest Fund Strategy (20 July).

The current Economist asks an important question: what went wrong with economics? Unfortunately, it comes up with superficial answers.

The magazine identifies three common criticisms of economics. That it helped cause the crisis, that it failed to spot it and that it has no idea how to fix it.

No doubt, these are widely made attacks on economics. But they do not get to the nub of what is wrong with the discipline. For example, in relation to the first one, the Economist says it is “half right”. Economists placed too much emphasis on targeting inflation and too little on asset bubbles.

But this view is far too flattering on the importance of economists, while grossly underestimating the underlying causes of the crisis. No doubt, asset bubbles were inflated in the run-up to the current crisis. But these were a symptom of atrophy in the real economy, rather than the result of policy errors or human greed.

Asset bubbles were inflated largely as a result of state action to offset the effects of a sagging economy. Interest rates were kept low and state spending high in an attempt to maintain economic momentum.

The inability to recognise this relationship reveals the first key weakness of contemporary economics. Its one-sided emphasis on consumption. The production side of the economy is relegated to a subsidiary role. As a result, key measures of economic health get little attention. Profit rates and labour productivity warrant barely a mention in much economic discussion. Instead the emphasis is on such things as share prices, official interest rates and inflation.

This fixation with consumption is related to another weakness of economics. The emphasis on stability, rather than growth.

Such a focus was apparent in the report on the British economy published by the International Monetary Fund (IMF) last week. A related statement said the IMF’s directors: “emphasised the importance of following credible and consistent policies to maintain domestic and external stability, limit downside risks and strengthen market confidence. Resolving the problems in the financial sector and setting monetary and fiscal policies consistent with a firm commitment to price stability and fiscal sustainability are the main policy priorities.”

Such an overwhelming emphasis on stability is central to economic orthodoxy. In Britain, Gordon Brown is one of its leading proponents. Yet it makes little sense. What brings wealth and prosperity is economic growth, rather than stability.

From this perspective, economic disruption can be positive. If it involves a restructuring, which leads to a more dynamic economy, it should be welcomed. Yet attachment to stability, rather than growth is another of the blind spots of contemporary economics.