Comment of the week: Redefining economics to redefine the economy

from Merijn Knibbe

A comment on Free e-book: “Britain’s Broken Economy – and how to mend it”

Redefining economics to redefine the economy

Once upon a time, economists like Milton Friedman, Gary Becker and Robert Lukas redefined economics with concepts like ‘Permanent Income’, ‘Human Capital’ and ‘Rational Expectations’. There might be some value in at least the first two of these concepts. But it is not just these individual concepts. These (and other) concepts are linked by three common denominators which makes them neo-classical: atomistic man, rational choice and efficient markets.  These denominators are, in my view, not needed to define these concepts – but at present they are at the core of it. These concepts, in a less precise shape, are also cornerstones of neo-liberal thinking and are (or were?) even part of what Germans call modern ‘Zeitgeist’, the ‘atmosphere’ of a certain era (there is a surprising similarity between the ‘You can do it if you want it’ individualism  part of the new age movement and ‘rational neo classical man). The e-book does a good job when it, implicitely, attacks this ‘Zeitgeist’ by, for instance, stating that job security is not just a ‘rigidity’ which hampers the working of efficient markets – but also a cornerstone of many peoples live. It does not do a good job – in fact: a bad job – when it wants to restrict these ideas to ‘Labour’. The very succes of neo-liberal ‘There is no such thing as society’ economic ideas is partly caused because left wing as well as right wing economists have embraced these ideas. Or, I do dare to state this for my country, they are often not even aware of alternatives. Many Dutch economists are, for instance, probably not able to mention even one Dutch economic historian, have never mastered double entry accounting, are not familiar with National Accounting and know next to nothing of modern consumer studies. Indeed, these are not radical methods, but that’s exactly the point. So called ‘radical’ Post Keynesian ideas are quite consistent with i.e. mainstream modern consumer studies – while neo classical economics are not. It’s not the Post Keynesians (or the Georgists, or…) who are the fringe-thinkers!

When we want to succeed in changing economics for the better, i.e. in the direction of a more real life science which does take account of the importance of social bonds, uncertainty, the difference between labor/entrepreneurial incomes like profit and wages and rentier incomes like rents and bonuses and which recognizes cultural differences we will have to redefine economics again – the individual concepts as well as the ‘worldview’ behind these concepts. As part of my (very) long term goal, ‘Indices of food and housing as indicators of human welfare, 1600 – 2020′ I will try to make a humble contribution to such a redefinition. None of the individual parts are new, all of it is consistent with National Accounting and double entry bookkeeping but the combination of the individual items may be slightly less usual.

1. A redefinition of investing and saving which includes consumer durables.

In National Accounting and Keynesian economics, saving is basically seen as producing something (capital goods, stock) which is used in a later period. The same holds, of course, for consumer durables. As durables are already a seperate item in the consumption statistics, we already know the magnitude of these investments. In Keynesian models, ‘C’ will drop and ‘I’ will rise, just like ‘S’. In fact, houses are already counted as capital and included in ‘I’ and ‘S’. GDP will rise, as well as NDP (consumer durables will be treated the same way as houses). Behind this definition is the idea of the household (read: family) as a producing as well as a consuming unit.

Bos, F. (2003), “The national accounts as a tool for analysis and policy. Past, present and future”. Berkel en Rodenrijs. Especially paragrpah 6.5.

2. Redefining inflation.

The largest single item in the ‘basket’ of goods used to calculate inflation is ‘housing’, including energy and the like. This holds for the USA (thanks, Dean Baker) but, according to the National Accounts, also for the netherlands and, according to the ‘baskets’ used to calculate inflation, also for Germany, the U.K. and France. But not for India. Sideline: a consistent very long term increase in the cost of housing (as well as of the quality of it) might be characteristic for very long term economic growth – but at the moment that’s just a hypothesis). Generally, the ‘price’ of housing is rent, or, for owner occupied dwellings, ‘imputed rent’. The reason why ‘imputed rent’ is used is straightforward: it is closer to a ‘monetary efficient market’ price than costs of housing of an owner occupied house, like interest, write offs and the like. But that’s exactly the problem. Households as a producer which own a house do not operate on a ‘monetary efficient market’ – and our statistics should reflect this. There is no ‘market price’ of house services once the house has been bought, not even a ‘shadow price’ – there are costs (for doubters: calculate the shadow prices for cases where house prices as well as interest rates drop after a house has been bought – do such calculations make sense?).

On this: Mason Gaffney, http://commonground-usa.net/gaffney_1205.htm

3. A ‘long term double entry accounting view of market transactions’.

Market transactions, by definition, have to be booked at the left as well at the right side of the accounts. For a person, this does not make much sense when one buys an icecream. But it does make sense when one buys a house (or a car, or other large items). To be honest: it makes so much sense that the bank every month reminds me of the passiva side of my balance sheet. Money, in the shape of debt, is surely not neutral, just read the Dean Baker op eds on housing. As obvious as this is, the standard ‘supply/demand’ miro economy graphs in fact only show the ‘activa’ side of transactions; liquidity constraints and debts are, in fact, not problematic. These problems are, of course, often added as a ‘complication’ – but should be seen as core elements of demand functions. Demand is not just influenced by the budget and prices – liquidity constraints in combination with ‘live events’ have their own role to play. Some years ago, ‘The Economist’ stated that ‘Bridezilla’ had caused the cost of the average USA wedding to increase to $ 28.000,–. For South Africans, the largest outlay of their lives may well be their funeral (is this at odds with the idea of ‘homo economicus’?). In many societies, dowries cause large liquidity problems – and people are even killed because of these. On a very theoretical level it is important to note that many of these financial problems are not solved, but caused by the existence of money. More practical it is important to note that liquidity as well as income and ‘rights to different kinds of credit’ are important determinants of spending, while these ‘rights to credit’ are continously changed by changing rules as well as changing reputations of certain assests (houses!) as well as people (‘creditworthiness’) (Study loans are of course on the increase as a major ‘liquidity constraint’).

On reputation, credit and consumption: Harm Nijboer, ‘Fashion and the early modern consumer evolution. A theoretical exploration and some evidence from seventeenth century Leeuwarden,’ in: Bruno Blondé, Eugénie Briot, Natacha Coquery & Laura van Aert (eds.), Retailers and consumer changes in Early Modern Europe. England, France, Italy and the Low Countries, Tours: Presses Universitaires François-Rabelais, 2005, pp. 21-36. On cultural differences in costs of ‘life events’ like funerals, marriages, religious feast and the like and liquidity constraints and savings: Collins, D., e.a. (2009), ‘Portfolios of the poor. How the World’s poor live on $2 a day’. Princeton.

Well, these were some ideas, maybe there is some merit to them. The unifying background of these ideas is the household as a producing unit which is embedded in a society and culture – but probably that is clear already.

Redefining economics to redefine the economy Once upon a time, economists like Milton Friedman, Gary Becker and Robert Lukas redefined economics with concepts like ‘Permanent Income’, ‘Human Capital’ and ‘Rational Expectations’. There might be some value into at least the first two of these concepts. But it is not just these individual concepts. These (and other) concepts are linked by three common denominators which makes them neo-classical: atomistic man, rational choice and efficient markets. These denominators are, in my view, not needed to define these concepts – but at present they are at the core of it. These concepts, in a less precise shape, are also cornerstones of neo-liberal thinking and are (or were?) even part of what Germans call modern ‘Zeitgeist’, the ‘atmosphere’ of a certain era (there is a surprising similarity between the ‘You can do it if you want it’ individualism of part of the new age movement and ‘rational neo classical man). The e-book does a good job when it, implicitely, attacks this ‘Zeitgeist’ by, for instance, stating that job security is not just a ‘rigidity’ which hampers the working of efficient markets – but also a cornerstone of many peoples live. It does not do a good job – in fact:a bad job – when it wants to restrict these ideas to ‘Labour’. The very succes of neo-liberal ‘There is no such thing as society’ economic ideas is partly caused because left wing as well as right wing economists have embraced these ideas. Or, I do dare to state this for my country, are often not even aware of alternatives. Many Dutch economists are, for instance, probably not able to mention even one Dutch economic historian, have never mastered double entry accounting, are not familiar with National Accounting and know next to nothing of modern consumer studies. Indeed, these are no radical methods, but that’s exactly the point. So called ‘radical’ Post Keynesian ideas are quite consistent with i.e. mainstream modern consumer studies – while neo classical economics are not. It’s not the Post Keynesians (or the Georgists, or…) who are the fringe-thinkers! When we want to succeed in changing economics for the better, i.e. in the direction of a more real life science which does take account of the importance of social bonds, uncertainty, the difference between labor/entrepreneurial incomes like profit and wages and rentier incomes like rents and bonuses and which recognizes cultural differences we will have to redefine economics again – the individual concepts as well as the ‘worldview’ behind these concepts. As part of my (very) long term goal, ‘Indices of food and housing as indicators of human welfare, 1600 – 2020’ I will try to make a humble contribution to such a redefinition. None of the individual parts are new, all of it is consistent with National Accounting and double entry bookkeeping but the combination of the individual items may be slightly less usual. 1. A redefinition of investing and saving which includes consumer durables. In National Accounting and Keynesian economics, saving is basically seen as producing something (capital goods, stock) which is used in a later period. The same holds, of course, for consumer durables. As durables are already a seperate item in the consumption statistics, we already know the magnitude of these investments. In Keynesian models, ‘C’ will drop and ‘I’ will rise, just like ‘S’. In fact, houses are already counted as capital and included in ‘I’ and ‘S’. GDP will rise, as well as NDP (consumer durables will be treated the samae way as houses). Behind this definition is the idea of the household (read: family) as a producing as well as a consuming unit. Bos, F. (2003), The national accounts as a tool for analysis and policy. Past, present and future’. Berkel en Rodenrijs. Especially paragrpah 6.5. 2. Redefining inflation. The largest single item in the ‘basket’ of goods used to calculate inflation is ‘housing’, including energy and the like. This holds for the USA (thanks, Dean Baker) but, according to the National Accounts, also for the netherlands and, according to the ‘baskets’ used to calculate inflation, also for Germany, the U.K. and France. But not for India. Sideline: a consistent very long term increase in the cost of housing (as well as of the quality of it) might be characteristic for very long term economic growth – but at the moment that’s just a hypothesis). Generally, the ‘price’ of housing is rent, or, for owner occupied dwellings, ‘imputed rent’. The reason why ‘imputed rent’ is used is straightforward: it is closer to a ‘monetary efficient market’ price than consts of housing of an owner occupied house, like interest, write offs and the like. But that’s exactly the problem. Households as a producer which own a house do not operate on a ‘monetary efficient market’ – and our statistics should reflect this. There is no ‘market price’ of house services once the house has been bought, not even a ‘shadow price’ – there are costs (for doubters: calculate the shadow prices for cases where house prices as well as interest rates drop after a house has been bought – do such calculations make sense?). On this: Mason Gaffney, http://commonground-usa.net/gaffney_1205.htm 3. A ‘long term double entry accounting view of market transactions’. Market transactions, by definition, have to be booked at the left as well at the right side of the accounts. For a person, this does not make much sense when one buys an icecream. But it does make sense when one buys a house (or a car, or other large items). To be honest: it makes so much sense that the bank every month reminds me of the passiva side of my balance sheet. Money, in the shape of debt, is surely not neutral, just read the Dean Baker op eds on housing. As obvious as this is, the standard ‘supply/demand’ miro economy graphs in fact only show the ‘activa’ side of transactions, liquidity constraints and debts are, in fact, not problematic. These problems are, of course, often added as a ‘complication’ – but should be seen as core elements of demand functions. Demand is not just influenced by the budget and prices – liquidity constraints in combination with ‘live events’ have their own role to play. Some years ago, ‘The Economist’ stated that ‘Bridezilla’ had caused the cost of the average USA wedding to increase to $ 28.000,–. For South Africans, the largest outlay of their lives may well be their funeral (is did at odds with the idea of ‘homo economicus’?). In many societies, dowries cause large liquidity problems – and people are even killed because of these. On a very theoretical level it is important to note that many of these financial problems are not solved, but caused by the existence of money. More practical it is important to note that liquidity as well as income and ‘rights to different kinds of credit’ are important determinants of spending, while these ‘rights to credit’ are continously changed by changing rules as well as changing reputations of certain assests (houses!) as well as people (‘creditworthiness’) (Study loans are of course on the increase as a major ‘liquidity constraint’). On reputation, credit and consumption:Harm Nijboer, ‘Fashion and the early modern consumer evolution. A theoretical exploration and some evidence from seventeenth century Leeuwarden,’ in: Bruno Blondé, Eugénie Briot, Natacha Coquery & Laura van Aert (eds.), Retailers and consumer changes in Early Modern Europe. England, France, Italy and the Low Countries, Tours: Presses Universitaires François-Rabelais, 2005, pp. 21-36. On cultural differences in costs of ‘life events’ like funerals, marriages, religious feast and the like and liquidity constraints and savings: Collins, D., e.a. (2009), ‘Portfolios of the poor. How the World’s poor live on $2 a day’. Princeton. Well, these were some ideas, maybe there is some merit to them. The unifying background of these ideas is the household as a producing unit which is embedded in a society and culture – but probably that is clear already. Merijn.Knibbe@wur.nl

Merijn Knibbe

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