reading

The disastrous flaws in mainstream economics,
and how economies can serve our total wellbeing

Mainstream economics has multiple fundamental flaws that cause great harm to people’s lives, to societies and to the planet. This book concisely and simply explains the flaws, and uses modern knowledge and systems ideas to show how market economies can be more sensibly managed to deliver a healthy and more equitable world.

First published in 2013 by BWM Books Pty Ltd
Canberra, Australia

ISBN 978-0-9923603-5-1

1. Economics

Davies, Geoffrey Frederick, 1944-

This book raises many interesting questions, most importantly, why does anyone take economists seriously when it comes to discussing the economy?

-Dean Baker, Co-Director, Center for Economic and Policy Research, Washington D.C.

Geoff Davies has a very good idea. Economics has locked itself into an intellectual cul-de-sac. Even its failure to anticipate the global economic crisis was not enough to force it out. So let’s sack the economists and let real scientists take over this vital but currently dangerous discipline.

With delightful wit and insightful analogies, geophysicist Geoff Davies dissects the inconsistencies — and the inanities — of mainstream economics. Don’t blame Adam Smith, he makes clear, for the mess this mainstream has become. Blame the intellectually lazy and morally obtuse careerists who practice an economics that in no way, shape, or form resembles the science they claim it to be. In the end, Sack the Economists helps us understand, plutocracy never works — and neither does an economics that refuses to discomfort our plutocrats.

- Sam Pizzigati, Institute for Policy Studies, Washington, D.C., and author of The Rich Don’t Always Win.

If change is going to come, it will be from other professions, like physics, engineering and biology, who are used to modelling the dynamic, unstable real world rather than fantasies of equilibrium. They should be emboldened by this crisis to step onto the turf of economics and take the field over from the economists. Geoff Davies was one of the very first to do this, long before the current crisis hit, and his physics- and biology-inspired work is part of the promise of a future economics that is actually useful–unlike the downright dangerous fantasies of today’s neoclassical economists.”

Geoff Davies turns his critical scientific gaze on contemporary economic orthodoxy and finds it deeply deficient. His work makes a strong case for a radical reconstruction of economic arrangements if we are to live more fruitfully and harmoniously.

Imagine a much more equal and inclusive society than we have now. It has old-fashioned family values, solid local communities, and full employment in an efficient and sustainable market economy with a debt-free money supply and no executive plunder. Impossible? Perhaps. But Geoff Davies’ project is distinguished by such common sense, hard science, practicality, surprise, fine writing and expert contempt for orthodox economics, it’s a joy to read for visionaries and sceptics alike.

For all its apparent logic and orderliness neoliberal economics is also deeply irrational, as Geoff Davies lucidly illustrates in his immensely readable Economia … Davies, like many others is turning to an ecological model to explain our economic behaviour and its impact on the quality of our lives and on the planet.

- Keith Gallasch, RealTime magazine, June/July 2004: The arts, ecologically. Full article.

… one of the best analyses of the sustainability problem that I have so far encountered… The reader is taken on a journey of discovery that revolves around an excellent critique of economics, counterpoised against truly amazing insights into how all of life has self-organised from the simple origins of life through to the current complexity of the biosphere. … its lucid analysis from a systems perspective provides an excellent insight to …the often overlooked systemic role of the current financial system in driving unsustainability.

- Richard Sanders, CSIRO Sustainability Network Update 41E (pdf download, 464 kb). Full review

Everyone now knows that economics is a pseudo-science and that economists, in the words of the late Alistair Cooke, are “varieties of necromancers”. Still, there are few books that set out clearly why modern economic theory is humbug. This remarkable book — which systematically pillories modern economic concepts, from globalism to laissez-faire economics — has been written by a senior fellow at the Australian National University whose field of expertise is geophysics. A geophysicist writing about economics? Well, better than an economist writing about economics. If you are depressed whenever you hear an economic argument that common sense tells you is rubbish, then this is the book for you. Davies dissects modern economics and intelligently argues that it is possible to create a new economic system that will benefit society. This may be utopia, but it is utopia beautifully argued.

Davies has been very successful in bringing a wide range of related ideas together in an engaging and persuasive way. In addition his Part 7, Malign Money, provides a lucid explanation – which I have not seen elsewhere – of how the form of money supply chosen influences economic behaviour and social development – and of the damage caused by the neo-classical choice of monetary mechanisms.

- Change Management Monitor. Full review here; commentary comparing and contrasting Economia with Fritjof Capra’s The Hidden Connections download (pdf, 88 kb).

… wonderfully readable and easily the most inspiring critique I have seen of the legalised robbery which passes for economic productivity these days.

I find Davies’ arguments refreshing and convincing. They cannot be ignored. … if Davies is even half right, we, the people, must urgently modify the economic model which drives all of our financial institutions, nearly all of our current politicians and all of our public services.

- Bob Douglas, Emeritus Professor, Australian National University, and Chair of the Board of Australia21, reviewing in The Canberra Times 13 March, 2004. Download the full review (pdf, 620 kb).

In The Nature of the Beast Geoff Davies makes a valuable contribution to the public debate about the big issues facing humanity today. As that great Australian, Dr. Nugget Coombs, wrote after decades of esteemed public service:

Not many Australians have taken up this challenge. Geoff has. He raises important questions and criticisms of our present way of doing things, and offers pointers to a better economic system and a better human society. I admire that he sees the environment as having a central place in the design of a viable and sustainable alternative and that he displays an underlying faith in the capacity of people ultimately to think and act for the good of all.

In The Nature of the Beast Geoff Davies is much more in command of the material, and his text is highly readable and clear even for people who are not well informed about economics. … he makes an excellent effort to explain what’s wrong with the present way we think about economics and how we could easily change that to our great advantage. Essential reading.

1
Economists Don’t Know What They’re Talking About

The walking dead

In 1994 Paul Ormerod published a book called The Death of Economics¹. He argued economists don’t know what they’re talking about. In 2001 Steve Keen published a book called Debunking Economics: the naked emperor of the social sciences², with a second edition in 2011 subtitled The naked emperor dethroned?³. Keen also argued economists don’t know what they’re talking about.

Neither of these books, nor quite a few others, has had the desired effect. Mainstream economics has sailed serenely on its way, declaiming, advising, berating, sternly lecturing, deciding, teaching, pontificating. Meanwhile half of Europe and many regions and groups in the United States are in depression, and fascism is making a comeback. The last big depression spawned Hitler. This one is promoting Golden Dawn in Greece and similar extremist movements elsewhere. In the anglophone world a fundamentalist right-wing ideology is enforcing an increasingly narrow political correctness centred on “free” markets and the right of the rich to do and say whatever they like. “Freedom”, but only for some, and without responsibility.

Evidently Ormerod and Keen were too subtle. It’s true their books also get a bit technical at times, especially Keen’s, but then they were addressing the profession, trying to bring it to its senses, to reform it from the inside. That seems to have been their other mistake. They produced example after example of how mainstream ideas fail, but still they had no effect. I think the message was addressed to the wrong audience, and was just too subtle. Economics is naked and dead, but never mind the stink, just prop up the corpse and carry on.

Oh, but look! The corpse is moving. It’s getting up and walking. Time to call in John Quiggin, author of Zombie Economics: how dead ideas still walk among us⁴. Perhaps he’ll show us how to shoot it in the head, or whatever it takes to finally stop a zombie.

Well, I think it’s clear we can’t be too subtle. We need to speak in plain English, to everyone, and get straight to the point. Economists don’t know what they’re talking about. We should remove economists from positions of power and influence. Get them out of treasuries, central banks, media, universities, where ever they spread their baleful ignorance.

Economists don’t know how businesses work, they don’t know how financial markets work, they can’t begin to do elementary accounting, they don’t know where money comes from nor how banks work, they think private debt has no effect on the economy, their favourite theory is a laughably irrelevant abstraction and they never learnt that mathematics on its own is not science. They ignore well-known evidence that clearly contradicts their theories.

Other academics should look into this discipline called economics that lurks in their midst. Practitioners of proper academic rigour, like historians, ecologists, physicists, psychologists, systems scientists, engineers, even lawyers, will be shocked. Academic economics is an incoherent grab bag of mathematical abstraction, assertion, failure to heed observations, misrepresentation of history and sources, rationalisation of archaic money-lending practices, and wishful thinking. It missed the computational boat that liberated other fields from old analytical mathematics and overly-restrictive assumptions. It is ignorant of major fields of modern knowledge in biology, ecology, psychology, anthropology, physics and systems science.

Though many economists themselves may not realise it, economics is an ideology rationalised by a dog’s breakfast of superficial arguments and defended by dense thickets of jargon and arcane mathematics. The ideology is an old one: the rich and powerful know best, the rest of us are here to serve them.

The latest guise of this ideology is called neoliberalism (and also known as economic rationalism, market fundamentalism, Thatcherism, Reaganism and neoconservatism). It espouses “free” markets and minimal government: just the ticket for the rich and powerful to do what they want. “Freedom”, in this world view, does not really mean freedom, it means freedom of the rich from restraints imposed by the rest of us, usually through government. It means freedom to manipulate markets, the media and society for the benefit of a minority. It severely constrains the freedom of most of us. Neoliberalism is the sun-worship of the modern Pharaohs.

These claims may be a little controversial. While many will instantly recognise truths from their own experience, others might say yes, but not all economists are so ignorant. Well, it’s true I have overstated the case. Only most economists are so ignorant. So I’ll refer to mainstream economics, to distinguish it from various marginalised schools of thought and individuals, some of whom do actually have something useful to say about how economies work. For the in crowd, I’m talking about neoclassical economics, the economics built around the abstract neoclassical theory, the one that predicts economies are usually close to equilibrium and market crashes are impossible.

However everything I have said is true about mainstream, neoclassical economics. It is pseudo-science, and its adherents have no idea how economies work. That is why they allowed the US sub-prime mortgage bubble to blow up and burst, precipitating the Global Financial Crisis, and why they are making things much worse with austerity policies. Plenty of people saw the Global Financial Crisis coming, and warned about it, and plenty of people are now pointing out how austerity only makes things worse. But mainstream economists are blinded by irrelevant concepts and gross ignorance, and can see none of this.

I do not mean to malign economists personally, they are undoubtedly genuine people wanting to improve the world. However they have been sorely misled. They have been pumped full of equations and required to master difficult mathematical manipulations. This has left them and their professors little time to critically examine assumptions, history, relevant observations, other fields of knowledge and alternative possibilities. Most will have moved into a busy job and never had much chance to reflect on such things. However the profession collectively, and its leaders, are guilty of intellectual laziness, at best, and more plausibly of hubris. University professors are supposed to be continually renovating their field, bringing in new knowledge and new approaches, identifying inadequacies, finding more useful conceptions.

If you think I am being a bit harsh, I am not alone in this judgement. Here is a relatively “respectable” economist (meaning he was able to get at least a good second-rank academic job, at the University of Texas, in spite of his views). His name is James Galbraith⁵, and yes he is the son of the famous iconoclastic Harvard economist John Kenneth Galbraith.

There have been severe critics of mainstream economics for a very long time. Steve Keen³ cites in particular Piero Sraffa⁶ writing in 1926, John Meynard Keynes⁷ writing in 1936, and Hyman Minsky⁸ writing in 1977, but he also recites the names Blatt, Garengani, Goodwin, Kalecky, Kaldor, and Veblen “to name a few”. These people were not just criticising aspects of economics, they were saying that the central theory of free markets, which is known as the neoclassical theory, was wrong.

More recently, here is US economist and commentator Dean Baker⁹, co-winner of the Revere Award of the World Economics Association and co-director of the Center for Economic and Policy Research in Washington DC:

So most economists should be retrained for a job more suited to their skill set. (But not for poetry, or we might end up with more Vogon poetry, the third-worst poetry in the universe. On reflection, poetry relates to people and their perceptions, so economists can be ruled out of that profession too.) If any economists can demonstrate that their favourite theory bears some passing resemblance to the real world, they should be allowed to apply for another job using some of their present skills, but not as an economist, nor in an economics department.

Economies are not separate from societies, much less dominant over societies. Economies are the way societies make their living. If there is any pretence of democracy, then a society can choose to be however it wishes, and the economy would then, sensibly, be tailored to support that kind of society. So an economy is a subordinate part of a society. In a functioning biosphere, a human society is in turn subordinate to the biosphere, at least if it desires its descendants to be around for anything like as long as its ancestors.

Therefore the term economics needs to be superseded by something more expansive. The old-fashioned term political economy at least allows that human society is involved, if we generously interpret politics as the means by which we arrive at collective decisions. So Departments of Political Economy could be allowable, at least until we arrive at a more concise title than the Department of People, Societies, the Ways They Make Their Livings and Their Relationships With the Rest of the Living World.

A possibly appropriate term might be socionomy. It already sounds like a combination of sociology and economy. It might also suggest including the more material and quantitative aspects of society, with no disrespect to sociology intended. Later in this book you will encounter the term sociocracy, a more intrinsically social way of governing, so together they might allow room for new conceptions of how our societies work. But what about the rest of the living world? Ecosocionomy? Biosocionomy? I’ll leave it so someone more inspired.

Staying with political economy for the moment, the less benighted ex-economists might then apply to be Political Economists. Many of them would still fall at the second hurdle, due to the culture shock of encountering scholarly integrity, whereupon they too would be consigned to the communes and salt mines. Those few economists who made it into a new department would be stimulated and guided by their encounters with academics from other fields, who would bring knowledge, creativity and rigour.

Better ideas

A modest amount of investigation, using readily available observations and some modern ideas to make sense of them, readily shows there is no basis in theory or practice for the claim that free markets are the best possible way to organise an economy. That is the central tenet of neoliberal ideology, and it has dominated the world for the past several decades. So neoliberalism is wrong, and the fact the world is in a big mess is not a surprise.

The same investigation reveals that central planning of economies will not work either. Economies are much too nimble, lively, dynamic for that. Economies are more like living systems than clockwork mechanisms, which ought not to be a surprise since at least some components of economies - people - are living, social beings, as distinct from the calculating reptiles¹⁰ mainstream economists assume us to be. So an exclusively socialist economy is not much good either, as the Soviet Union and China found out.

Further investigation, using modern systems concepts with a dash of ancient wisdom, suggests economies, and living things, do not thrive if they are based exclusively on competition, to the exclusion of cooperation. Neither do they thrive if they are based exclusively on cooperation, to the exclusion of competition. That disposes of the two great twentieth-century ideologies. Neither old capitalism nor old socialism is any good, so we ought to give up fighting wars over them.

A bit of reflection will reveal that both competition and cooperation are important - in our daily lives, in our families and in any community. A healthy life balances our personal needs, and the expression of our uniqueness, with the needs of our family, community and society. That is normal. The neoliberal reliance exclusively on competition is an unhealthy aberration, just as much as the communist reliance exclusively on cooperation was an unhealthy aberration.

This line of thinking leads us towards a potentially much more productive way of thinking about economies. A herd of wild horses is potentially very powerful, but only if they can be tamed, harnessed and sensibly guided will they become useful to us. Similarly, markets are clearly powerful, but they need to be understood, harnessed and guided if they are to do beneficial work for us. Markets can be guided by managing the incentives under which they operate, with some regulation of obviously harmful behaviour.

If we rid ourselves of the ridiculous concepts currently imposed on our economies, there is a far healthier kind of economy waiting for us to try, and to learn its ways, neither socialism nor capitalism but transcending both. The mixed, social democratic economies of the post-war decades are the nearest approximation so far to what is possible. The period roughly from 1950 to 1970 saw the greatest gain in wealth of the greatest number (in the “developed countries”) of any modern period. GDP growth was high, unemployment was ridiculously low by current standards (averaging only 1.3% in Australia and around 3% in the OECD) and inflation was low. This was true even though governments involved themselves quite a lot in the economy.

For all the hype over the past few decades about freeing up markets, deregulating, privatising and all the rest, the resulting performance never matched the performance of those post-war decades. GDP growth was slower and unemployment was much higher. Median wages in the United States have hardly changed for thirty years, and inequality everywhere increased. Then came the big crash of the GFC, which ought to have totally discredited market-fundamentalists, but the evidence was already strong that freed markets were not working as well as the managed markets of the post-war decades.

However we can do better than social democracy, better than an uneasy truce between opposing ideologies based on simplistic views of human nature. Instead we can embrace as natural and healthy our innately opposing tendencies to cooperate and to compete, and learn to balance them in productive ways. That balancing is what makes life unpredictable, and rich.

The resulting economies could also be made compatible with the natural living world, which is good because at present we are rapidly ruining the world that is our total and exclusive life support system. It would be possible, in other words, to live well while respecting others and having the natural world thrive around us.

Promoting debate

In my experience even those economists who dissent most strongly from the mainstream still do not agree with all the criticisms I make, nor all the reforms I advocate here. I think that is mainly because we have very different perspectives. Anyone with any training in economics has to find their way out of the morass, and it tends to be difficult to “unlearn” things that have become familiar mental furniture. There is also a lot of agonising among “heterodox” economists about methodology and philosophy, symptomatic of a lack of experience with a real scientific approach. On the other hand I am an experienced scientist finding my way in from the outside. I might miss some things, time will be the judge of that, but perhaps I more readily recognise things that are unjustified, or I am more willing to name them and face the implications.

Perhaps I bring a broader perspective as well, and as a result focus on more than one problem. There are economists who agree more or less with each of the criticisms I make here. There are just none I can think of who would feature all of the problems highlighted here. Neither am I aware of any economist who straightforwardly draws out the fundamental implications of identifying economies as complex systems (Chapter 3) nor who argues for separating the supply of money from investment, thereby removing perhaps the strongest destabiliser of our highly unstable economies (Chapter 9).

Anyway I don’t see such differences among the dissenters as a problem. My main objective here is to break down the wall of silence that insulates the mainstream from criticism. If the subject is opened up, then we can sensibly debate our differences.

2
Boom Crash Opera

The Global Financial Crisis of 2007-8 became what is variously known as the Great Recession or the Second Great Depression, which still has much of the world in its grip. It is widely acknowledged to be the worst economic malfunction since the Great Depression of 1928-39. It is also notable because of the almost complete failure of the mainstream economics profession to anticipate it, let alone to adopt policies that would mitigate it or prevent it from happening at all.

Forever blowing bubbles

The Great Recession and the Great Depression are far from the only two such malfunctions. There was a severe depression in the 1890s and other booms and crashes stretching back through centuries at least to the Dutch tulip mania of the 1630s. More recently there have been the stock market crash of 1987, the Asian currency meltdown of 1998, the dot-com bubble of 2001, and national crises in Mexico, Russia, Argentina and Brazil. Because such crashes cause such disruption and misery, it is important to understand why they happen.

The GFC is a useful example because its cause can be seen more clearly than some. The GFC was triggered by the collapse of an excessive build-up of mortgage debt, in the United States in particular. In a nutshell, banks profit from making loans, loans allow people to bid up the price of housing, and higher housing prices are used as collateral for bigger loans. Eventually the loan repayments become too large for some people to afford, they default, prices start to fall, more people default, prices go into free fall, many people lose money, and many people lose their homes.

Usually a rising price spiral like that requires speculation to drive it to excess. If house prices continue to rise, speculators buy houses in the expectation they will be able to sell them later for a windfall profit. The speculation pushes prices higher still, hence the term speculative bubble. In the US there were other practices that blew the bubble to greater extremes than ever before. I’ll come back to those later.

The inflation and bursting of a speculative bubble is a signature of a market failure. Markets are supposed to send feedback signals that correct prices and pull them back to an optimum level before they deviate too far above, or below. A rising number of defaults should signal to the bank not to use rising housing prices as collateral for bigger loans. People would not then be able to bid the prices up further. However the greed of speculators blocks out that signal and allows prices to rise even higher. Thus we already have reason to question the zeal of market fundamentalists, who claim free markets almost always work and almost always are best.

This account also raises another important question that seems hardly ever to be asked. Why does the failure of some people’s investments, or some people’s gambles, cause such widespread disruption? If a gambler loses his money on the horses, he and his family suffer, but his money has just been transferred to the bookmaker who is free to spend it, so the economy as a whole is not much affected. If the mythical capitalist invests his savings in a new widget factory, but nobody wants widgets and he goes broke, then the capitalist and his family suffer, but the factory builders will have spent his money and the larger economy will be not much changed.

So, why does the failure of investments in a market crash disrupt everyone else’s routine business? In US vernacular, why does a crash on Wall Street cause such havoc on Main Street?

The reason, in essence, is that when you get a mortgage loan, the loan money that appears in your bank account is mostly new money, created out of nothing. The “loan” is not a loan of other people’s savings. Instead, only ten percent or less of the loan comes from other people’s savings and deposits, and the rest is created by a few strokes of a keyboard. Let there be $90,000 dollars, and let it come to rest in Joe Bloggs’ loan account. This fact is well known to bankers, and even to economists. If you search for “fractional reserve banking” you can read about it, though it probably won’t be explained as simply as I just did. It’s also a little tricky following the implications through several cycles of loan and subsequent deposit, and one good explanation is in a textbook by Heilbroner and Thurow¹¹. You may also read that bank loans these days are more complicated than the classic fractional reserve system, but that doesn’t change the essence of the argument here.

There are several really important implications of this way of making loans. For the moment I’ll just focus on one. A new loan increases the total amount of money in the economy. It increases the total purchasing power available in the economy. Conversely, as the loan is paid back the amount of money and purchasing power decrease.

If loans are being issued and paid back at a steady rate, then the total purchasing power in the economy will be steady. However if the number or value of loans is increasing, then so will total purchasing power. If you borrow money to have a new house built, then your builder gets some of that money, and he can go and buy a new TV. The new money flows on through other transactions, and the economy is thereby “stimulated”. If the total value of loans is increasing, then more money is being added to the economy and more people have more money to spend. Times are good.

On the other hand if you find you are overstretched and having trouble making your loan payments, then you may have to cut back on other spending - keep the old car going for a while longer, don’t eat out as much. If lots of people are cutting back like you, then spending slows, and the economy goes off the boil. Times are not so good.

In the US mortgage bubble, the number and value of loans kept increasing for a long time. Lots of new money flowed into the economy. So not only was the housing market booming, but the whole economy was stimulated. When the bubble burst, the amount of money decreased rapidly.

Some of the money simply evaporated. If a loan is defaulted on and the bank can’t recover its money from selling the house, because house prices have fallen, then the bank has to write off its “asset” (the money you owed it). Money, loans and debts are only built on promises, it turns out. We’ll look into that later. If I can’t fulfil my promise, then it becomes worthless. If I gave you a piece of paper saying I owe you a pig, but my pig dies, then my promise, my piece of paper, is worthless to you. It’s not necessarily anyone’s fault, perhaps it’s just from the vagaries of an unpredictable world. Promises involve risk, another theme we will pick up later.

Another reason the amount of money decreased is that more money was diverted into repaying loans. The sudden drop in money supply slowed business, reduced many incomes, and people had to stretch more to make their loan repayments. The sudden change to bad times made people more cautious, so they repaid loans faster than they might have otherwise, and they avoided taking out new loans. All of this further reduced the money supply. Business slowed further. Times became really bad.

This is why a Wall Street crash causes so much disruption on Main Street. It’s because the money supply goes up and down as the financial markets go up and down. It’s because new bank “loans” are made with new money created out of nothing. Other financial market dealings also effectively create new purchasing power. If the deals go bad, people on Main Street don’t have as much money to spend.

By the way, this is not how it’s supposed to work in the mythical version of capitalism. In the capitalist myth, the capitalist accumulates a lot of money (capital) and re-invests it. In the real modern world the capitalist borrows most of the money. So perhaps we should re-name the present regime debtism instead of capitalism.

Contents

1Economists Don’t Know What They’re Talking About

The walking dead

Better ideas

Promoting debate

2Boom Crash Opera

Forever blowing bubbles

1
Economists Don’t Know What They’re Talking About

2
Boom Crash Opera