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T C A Srinivasa-Raghavan: The Poverty of Economics

Can 21st century economic problems be solved with 20th century modes of analysis?

T C A Srinivasa-Raghavan 

T C A Srinivasa-Raghavan

Have you noticed how tired the ideas emanating from economists sound? Every century brings with it its own version of old problems. It also brings some new ones.

History shows that, generally, it takes the new century some time, perhaps as many as 25 years, to figure out that the old ways of tackling the new problems will not work. This is because what Marxists call "the objective conditions" have changed, either starkly or subtly.


One example of a stark change is this: this is the first time in history when there is a global over-supply of the main factors of production, capital and labour - capital because there is very little restraint on the printing of fiat money and labour because the death rate has come down so drastically. Basically, there are too many people and too much paper money around.

This is in contrast to the past when one or the other always used to be in short supply. Until not very long ago, the local shortages would be made up by either capital flows or migration. This no longer happens on the scale required.

Simultaneously, the over-supply has been accompanied by the Western idea that it is the individual - and not the group - who matters more in the overall scheme of things. Relative distributions aside, the resulting attempts at the maximisation of individual utilities has meant a reduction in overall welfare as can be seen from the massive dumping of carbon in the atmosphere. There are hundreds of other examples of this sort of thing.

The subtle changes, however, are harder to identify. But they are more numerous. For example, if you look at the preference orderings of the generation born after 1980, you will notice that those born after 1980 prefer more leisure because leisure is no longer an expensive luxury. This has important implications for productivity and, therefore, employment policies.

And so on.

Microeconomics
The question that needs asking now is this: how well equipped is modern economics to handle the new problems arising from this global plenitude of labour and capital? After all, it developed as a discipline based on the analysis of scarcity. All its tools are designed to deal with scarcities, not surpluses.

My economist friends say economics has been concerned with scarcities in the production of goods and services, not in the factors of production. That is why efficient resource allocation became so important.

This is absolutely true when cross-border flows of both labour and capital were completely free. But that is no longer the case because there are more sovereign jurisdictions now that limit such flows.

Also, even if true, it is true only of - and even there some new thinking is called for. Strictly speaking, on a global scale, the returns to labour and capital should be on a secularly declining trend. What does this do to the standard microeconomic theory of, say, firms? Do we need more competition or less? Think before answering.

Macroeconomics
And how will cope? For instance, does the identity GDP _ _ _ C+I+G+(X-M) state an inter-temporally valid truth?

Assuming that it is indeed such a truth because democracy assigns a major role to "G" in modern economies, what form will it take? Is "G", which is essentially determined by politics, to consist mainly of tax revenue or will it contain the second "P" in PPP (public-private partnership) as well? If the latter, how do you induce it in adequate quantities without reducing the first "P"?

Many such questions can be asked and doubtless there will be more than one answer to each question. But whether they will be sufficient unto the day will depend on the thought processes that have generated the answers.

I doubt that the old way of looking at things will solve the 21st century's problems. The real problem is whether a new theoretical approach will be devised - a la Keynes in the 20th century - and if it can be synthesised into something that minimises, if not eliminates, the frictions between the new competing claims.

The core issue
At its very core, the problem that confronts economics lies in the fact that while national economies have become global and their interstices become interdependent in a degree never seen before, the politics of those economies has turned more inward because of democracy, which seeks to maximise the individual utilities of the citizens at the expense of the overall good.

This is quite the opposite of the situation that Keynes was dealing with where such maximisation was important only in a few countries of the Western hemisphere. The rest had no voice.

In every other discipline, new problems are solved by new theories based on the current reality. Economics, like the pre-Copernican flat-earthers, is lagging far behind.

The author will respond to comments on this column on Monday - see www.business-standard.com

First Published: Fri, July 25 2014. 22:44 IST
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