The Real Economy

Part 2 - Is there a problem?

A Real Incomes approach (RIA) to economics is a way of analysing the economy which provides useful insights as to feasible social, political and economic objectives and useful tools for securing those objectives through policy. Of fundamental importance is that RIA provides a basis for fashioning macroeconomic policy which achieves a functional coherence between macroeconomic and microeconomic operational objectives. The policy objectives of RIA are to:

support normal management decisions to secure higher real incomes
achieve an acceptable level of distribution of real incomes
avoid disruptive monopoly market interventions by the state such as the practices of demand management and/or fixing of money rental (interest) rates

Current approaches to macroeconomic analysis and policy-making have not moved very far from a perspective which gained acceptance in post-1945 Britain. As this section will show this has exposed and continues to expose the British economy to possible future instabilities arising from the combination of so-called freer markets and an intensification of globalization. This is not a stand against free markets or globalization but rather a call for macroeconomic management which is more relevant and attuned to the needs of the population of a participatory democracy1 where the defence of individual freedom is paramount in the face of changing international circumstances. So, if there is a problem, what is it? In order to spell out the problem it is necessary to spell out some recent history and the role of economic policy. The most important period for this discussion is 1945 to the present date. I make no apology for this somewhat drawn out story but the purpose is to make clear an analysis of events which have occurred over the last 63 years and with which most economists are familiar having lived through some parts of the period concerned. The story is a mix of events, policy actions and outcomes of various types all subject to varying interpretations from the standpoint of economic analysis.

Policy-induced instability, the stop-go syndrome

Post-1945 the basis of macroeconomic management, that is of the whole economy, was largely based on a Keynesian model aimed at sustaining full employment. This had become a vital macroeconomic objective after the experience of the Great Depression of the 1920s and massive unemployment after the New York Stock Exchange Crash of 1929 and, indeed, experience with government-directed munitions manufacture and the economic management of the “war effort” during hostilities. John Maynard Keynes’ book on this topic was his well known, "The General Theory of Employment, Interest and Money" published in 1936. This advocated a government-sponsored policy of full employment. Experience with managing armaments manufacturing during the Second World War gave politicians some confidence that Keynesianism might well provide a practical basis for management of the economy. The economic instruments applied were principally designed to control overall demand levels in the economy through the crude policy variables of taxation and government expenditure through such things as public works. Interest rates were also used as a basis for encouraging the policy targets of higher investment and raising levels of credit and therefore consumer demand through a reduction in interest rates or a reduction in investment and or consumer credit by raising interest rates.

All such policy instruments involved the use of variables with different effects within the economy some "differential" and all "lagged". In other words once different effects went into action it has always been difficult to reverse them within a short period. One of my economics professors at Stanford, Laurie Tarshish, who had been one of Keynes' students at Cambridge, used to express this dilemma as the ability to apply the policy strings to pull the economy forward but you then face the problem that you can't push on a string! As a result there were policy-induced destabilizing cycles of "overheating" economies marked by inflation and the need to introduce mini-depressions by reducing demand, often leading to “overcooling”. Thus the origin of the common syndrome known as stop-go and the attendant policy-induced economic cycles.

Continued....

¹ Although the British political system is referred to as a Parliamentary democracy a recent review² of the British political system points out some 58 constraints on individual freedom of expression, as reflected in preferences. The system does not promote participation as a basis for identifying preferences and accordingly governance, as reflected in Parliamentary decisions, does not reflect the will of the people. The constitutional efforts and settlements required to bring Britain to a position where a constitutional defence of individual freedom secures a Parliament reflecting the will of the people, requires a range of constraints upon the arbitrary behaviour of political parties.

It is self-evident that if, on the side of economic management, we also fail to sustain economic policies which protect individual freedom, as expressed in the form of preferences, then we face a situation where both individual freedom and the constitutional guarantees for such freedom are easily undermined.

By way of example, Keynesianism's most notorious failure was in the face of a global economy event relating to the price of an important commodity, petroleum being used as a strategic development tactic against the background of political tensions in the Middle East. Monetarism is failing now, as will be reviewed in this tutorial and in the News section of Real Incomes, to manage the commoditization of money. The current period parallels that of the 1970s where "standard policies" are clealy not adequate.

British politicians promote "globalization" and "free markets" but macroeconomic policy needs to advance to protect the economy from exogenous market forces generated outside and beyond the control of the national macroeconomic policy instruments, variables and targets. As a result there is an increasing exposure to strategic foreign policies operating through tactics which influence markets and which are manipulated by, sometimes, unfriendly agents or states.

² "The Briton's Quest for Freedom - Our unfinished journey." McNeill, H.W., July, 2007, Hambrook Publishing Company, ISBN: 978-0-907833-01-7

©2007-2008 Hector McNeill This tutorial series has been prepared by Hector McNeill based upon articles, papers and reports on research & development on the Real Incomes Approach. The series is suitable for anyone interested in an objective analysis of the structure of economies with a view to identifying appropriate policy objectives and tools. Hector McNeill is the Director of SEEL, the Systems Engineering Economics Lab.