Evolution of Economic Theories and Solutions — TheInternetOfValue — 03

The last chapter was on analyzing the problem deeper. Today we shall look at the past economic solutions in conjunction with the evolution of economic theories.

Morality and economics go hand in hand. When moralities evolved, economic theories were revised. The issue, of course, is that often millions are adversely affected when we make mistakes.

In our inquiry, we will begin our journey with Adam Smith, the father of capitalism. He published The Theory of Moral Sentiments in 1759 and, then in 1776; he published “An inquiry into the nature and causes of the wealth of nations.”

Smith proposed that a person following their self-interest could end up serving the common good. He suggested “free trade” when it was still sexy to levy high taxes and protect their domestic producers.

A generation later, David Ricardo / JOhn Stuart Mill (opinion varies) introduced “comparative advantage” to add meat to Smith’s free trade argument. “When both focus on what they are best at and then trade, everyone benefits.” This led to economics as a field flourishing with “private properties” and “free market.”

75 years later, Friedrich Engles & Karl Marx looked at economics class instead of examining individual behavior and published their work as the “Communist Manifesto.” This led to workers overthrowing their bosses, ushering in a stateless & classless system called “communism.”

Two groups naturally emerged one endorsed free-market capitalism, and the other advocated collective ownership of the factors of production, or communism.

Till the end of the 19th century, market-based economic theories dominated the world with contributions from French, British, and American economists. This body of thought is called classical economics.

In the early 20th century, when the Soviet Union established itself and the wealthiest counties faced a great depression, the theories of Adam Smith and Marshall failed to explain the circumstances, let alone help the government fix it in any way.

Enter John Maynard Keynes. In a 1936 book titled “The general theory of money,” he introduced interest and employment, which birthed macroeconomics

He reasoned that unemployment was primarily because of lack of demand and mocked classical economics for suggesting that demand would go up in the long run when wages and labor requirements equalized. “In the long run, everyone is dead,” he said.

Keynes instead proposed that the government ( state ) should intervene and provide the stimulus; and if necessary run a very large budget deficit to create jobs.

They should

  1. Raise loans to make massive infrastructure
  2. Become primary shopper in the land, creating demand until more widespread sources of demand can return.

Businesses have more money, government cuts down on unemployment subsidies, thus increasing employment, spending power and eventually taxes which pays off the debt that government raised, ideally speaking. Keynes also claimed that a global system of economic organization was possible if countries resorted to a standardized unit of account called #Bancor, a pseudo currency, for the purpose of global trade. Such account will help to penalize the governments that were running large deficits or surplus. This system would thus help ease the boom-bust cycle of economies.

USA was running large trade surpluses, so it naturally opposed Bancor, however other suggestions were agreed upon, such as the World Bank, IMF, and they changed the world. ( Right ?)

Since the great depression, many counties pursued a political and economic ideology called “socialism”, where there is private property in markets, but also have government ownership of major industries, universal healthcare etc.

For almost 3 decades after the WW2, Keynes’ ideologies were applied across the nations and things looked good but in the 1970s, Friedman and Hayech argued for smaller government, free markets and reduction in regulation of capital enterprise. At the same time, stagflation settled in, and Keynes’ model could not explain it, so it was discredited, and the Neo-liberals took over.

Austrian economists Friedrich Hayek and Ludwig Von Mises argued that heavy state involvement never produced the output it promised and regulation and government tinkering were a problem and not a solution, while Milton Friedman advocated privatization of many functions and de-regulation of the economy, establishing Austrian and Chicago school of economics respectively. Friedman’s theory on monetarism focused on price stability and argued that money supply should be increased slowly and predictably for steady growth ( Hi #Bitcoin ). The new classical synthesis can be summed up as classical economics + monetarism + Keynesian economics.

This free-market capitalism led us straight to the financial crisis of 2008. We’ve covered enough of this in the previous chapter. Irrespective of which institution (state/market) has the power the wealth gap has remained the same. So we dig deeper into the labour component. Keynes criticized the classical economics way of dealing with unemployment because he claimed that demand catching up with supply or the other way around, would take time. And why would it take time ? Because there are frictions in the labor market. The 2010 Nobel Prize in economics was a labor economics paper that looked at these frictions. You can read the conclusion here

The point to note here is that it has been 10 years and what have we done to reduce labor market frictions? very little. Friction-less money is fine, but the labor that you pay for is still marred with frictions. Adam Smith said, “the value of anything is the labor that has gone into it or the labor you can demand”. If we make labor frictionless and gamify to be financialized we will be financializing the real economy like modern Keynesians, @Mazzucato, suggest.

Summary: A quick economic thought evolution and the idea of labor market frictions as the key research area to proceed further.

In the next article, we shall look at Labour Market Frictions in detail and a theory of a frictionless skill movement system

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