Need for New Economic Theory & Measures

 

Need for New Economic Theory & Measures[*]

By Ivo Slaus and Garry Jacobs [†]

New for New Theory

The world’s economic system has generated unprecedented prosperity over the past half century. Side by side it has generated a large class of the economically disenfranchised, high levels of unemployment, rising levels of income inequality, financial instability and economic insecurity, and unnecessary suffering and deprivation. These problems are a product of our thinking, conception, theory. Solution lies in new thinking, new theory. Today the world possesses the capacity to generate prosperity for all. A change in conception is essential for greater economic achievement.

Need for a comprehensive, evolutionary social perspective

Economy began as a sub-discipline of political science called Political Economy. Overtime it narrowed its range to focus on specialized issues –markets, money, prices, production, finance, trade, employment and public policy. As finance is a part of economy, economy is a part of Society. New Economics needs to extend the circumference of its vision beyond markets, money, finance and public policy to view the society as a whole. This means understanding the development of economic activity in the context of the evolution of other dimensions of social development, including transportation, communication, technology, organization, education, knowledge, governance, international relations, social attitudes, human values and other factors. These factors are not mere peripheral or incidental to economy. They constitute the foundation and bedrock on which it operates and grows. A change in view will reveal the existence of vast untapped social potential that can be harnessed for more rapid and stable economic development. Society is undergoing a continuous process of evolution. Economy needs to be predicated on an understanding of the general laws that govern the broader field of social development and evolution. Harlan Cleveland affirmed this view in the early 1950s when he recognized the significance of what he termed the “revolution of rising expectations” on economic progress in East Asia.

Newtonian vs. Human-centered perspective

Economics not only needs a wider circumference, but it also needs a new center that shifts the focus from money and markets to human-beings. Human welfare and well-being must regarded as the primary objective of economic activity, not a subsidiary or beneficial side effect. A fundamental difference between the physical and social sciences is often overlooked. The physical systems are governed by universal laws of Nature. Economic systems and other social systems are determined primarily by human beings rather than Nature. Economic systems are man-made -- The laws of economics are man-made. We cannot regulate Nature’s functioning by legislation, but we can change the functioning of economic systems simply by a change in attitudes and values. Laws against usury date back millennium. Zoning laws, fair trading, full disclosure, minimum wage, labor rights, anti-trust laws are just a few of the countless ways in which human decisions determine the functioning of economic systems. We, not laws of Nature, determine how our economy works – human values, attitudes, expectations. It is question of human choice. Yet all too often we speak about markets as if they are a law unto themselves and must be left to regulate themselves. We do not allow unbridled unregulated freedom in any field of life – child rearing, medicine, environment, law and order, governance – yet we not only permit but believe in the efficacy of unregulated markets. This is a superstition. A shift is needed from the Newtonian view that economics adheres to certain universal unchanging laws akin to the physical sciences to recognize the primacy of human beings as the determinant of economic systems. It is human energy, conceptions, aspirations, attitudes, and creative capacities that ultimately determine the scope and functioning of economic systems, not money and markets or even public policy. When people expect market to rise, it rises. When people demand environmental protection, we get it. Human understanding and expectation are all-powerful determinants, as witnessed in the USA in the 1930s, Japan after 1990, and in Europe and USA during the past few years when public policy was helpless in the face of a loss of public confidence.

Evolution of Economy from Agriculture, Production & Trade to Services

The Wealth of Nations was written at the dawn of the Industrial Revolution, at a time when Europe was in the early stages of transition from an agrarian, rural based economy to one increasingly based on manufacturing and international trade. It was a time when most essential and desirable goods were in short supply. In agriculture, land is the primary field of economic activity. At that time, about 80% of the world’s population lived at subsistence levels engaged in agriculture. In industry, the factory is the field of production and capital, physical energy and other material resources become the main resources. In trade, the field shifts from material resources to human relationships. The energy that drives trade is human energy, the human aspiration for higher levels of material consumption and the dynamism generated by opportunities to reach out to undeveloped markets. That dynamism is a hundred-fold greater than that generated by mere production. Trade extends and multiplies wealth by relating positively to wider geographic areas, larger populations and a greater variety of human needs. In services, the field shifts again from material needs which are subject to inherent limits to social and psychological needs for knowledge, education, entertainment, communication, transport which are virtually unlimited in potential. The service economy now accounts for 64% of global output and 70% of employment in OECD countries. Its contribution is even larger when the service dimensions of manufacturing are taken into account. This necessitates fundamental changes in the way value is measured. Through this process the center of economy has shifted progressively from material things to human beings. Things are limited, but human potential is not. It is constantly extended by human aspirations, imagination and creativity, which are not subject to finite limits. Our material needs may be finite, but our social, intellectual, psychological and spiritual needs are not; and we constantly create new and higher types of products and services to meet those needs. The basis of economy is progressively shifting from the physical to the intangible. The human propensity for consumption is potentially unlimited. But the real goal is not perpetually higher levels of consumption. It is higher levels of human welfare and well-being, which are best served by progressively shifting the focus of development from material to social security and psychological fulfillment. Theory needs to evolve to reflect this shift from to society, human relations and higher level human needs as the basis of economy.

Scarcity & Surplus

Economics evolved as the science of scarcity based on a scarcity or arable land and a scarcity of capital for industrialization. As a result of this evolution, the productivity of society has multiplied thousands of times. Today the total capacity of global society for meeting human needs and fulfilling human aspirations is immeasurably greater in quantity and quality than ever before, and it is expanding at an accelerating rate. Today the world possesses the productive capacity to produce many times total global demand for a wide range of products and services. As Orio Giarini observed 30 years ago in report to the Club of Rome entitled Dialogue on Wealth and Welfare, the Club’s report on Limits to Growth heralded the decline of economic growth based on industrialization, not on growth itself. Growth is a natural human urge. What we need is a progressive shift from excessive focus on material things to emphasis on higher level needs such as health, education, security, human interaction and entertainment. The world today suffers from excess production capacity backed by insufficient purchasing power. Increasing production capacity is no longer a sufficient premise for wealth generation. The main limitation on growth today is not money or materials but rather the purchasing power of individual consumers. Therefore, growth of employment opportunities becomes the essential foundation for continuous economic growth.

Money

During the time of Adam Smith, capital was a scarce resource essential for industrialization. Today the world is flush with surplus capital resources. According to McKinsey global financial resources increased from $12 trillion in 1980 to more than $160 trillion in 2007. Every day $4-5 trillion in financial assets move around the world in search of higher returns. Speculative investment of this surplus has become a major source of instability. The primary result of this movement is unstable exchange rates, fluctuating share prices and inflated asset values. The recent international financial crisis is the result of the failure of the global organization of finance to keep evolve rapidly enough to absorb the increasing financial surplus. If the world’s financial surplus were intelligently invested in productive investments that create jobs and thereby enhance purchasing power for consumption, it would be sufficient to usher in global prosperity and multiply the financial assets many fold. Money is a human invention. Money is an instrument, tool and symbol that has evolved unimaginably over the past five centuries from metallic coins and paper currency to digital money, and a wide range of credit and other financial instruments. Money is no longer backed by precious metals or any other material resource. It is backed by the entire productive capacity of the society, present and future and is only limited by the capacity of the society to harness and utilize that potential. The potential for money creation has only very partially tapped, perhaps only to the extent of 5% or less. Money is only an instrument. It does not act morally or immorally any more than technology or markets other human inventions. It is man who decides whether money will be used positively for productive purposes or negatively for speculation. Man is the center of power and the determinant. Development of human values, attitudes and understanding are the means.

Untapped Society Potential

The growth of economy is driven by the underlying development of society. The social potential is unlimited and ever expanding as illustrated by continuous and accelerating technological development and innovation, increasing speed, reach and intensity of communications, and transportation; proliferation of information; rapid spread of education, increasing capacity; and organizational innovation. Organization is an unlimited social resource. The international financial crisis, nuclear weapons proliferation and ecological problems we face today arise because the global community has not yet evolved effective social organizations beyond the level of the nation state. While exports represent 20-25% of global product, economic theory is still modeled on the premise of the nation state as the basic unit and national competitive advantage as the optimal strategy. It is designed to maximize domestic rather than global employment and prosperity. Innovations in social organization range from local level micro-finance to the global internet. At the global level the most successful social organizations are those which have shifted from a purely competitive model to one based on cooperation, e.g. international air travel, telecom, credit card transactions, and Internet. At a time of increasing global integration, economic theory is still based largely on a competitive model evolved in the 18th century. This applies to models of employment as well. The internet may represent the first truly global social organization, which already links together nearly half of humankind people, rather than merely national governments. Surely we have not yet tapped even a tiny portion of the potential of this organization for knowledge, education, employment, business, social and cultural enrichment. The same gap between potential and utilization is there even in the most economically advanced countries which do not tap more than 1-10% of this potential, because it keeps growing as they develop further. The time for diffusion has declined from decades or years to days or hours in many cases. A comprehensive catalog of global social resources will clearly document the enormous un-utilized potential.

Human Capital

Human capacity is the ultimate resource. Today human beings have become the most precious and productive resource, not technology or capital. Indeed it has always been the case. It is the human mind that creates or recognizes a resource. e.g. sand that was used to make bricks or glass is not used to make silicon chips and fiber optic cables. While most material resources are limited or scarce, the human resource admits of unlimited development. There is no limit to the extent to which people can develop in terms of their knowledge, skills, aspirations, attitudes, values and creative imagination. Therefore the future of economics lies in increasing emphasis on full development of human resources. The human resource is also the basis of the market. The more we develop people and engage them productively, the more they aspire to consume. The individual is the ultimate resource and determinant of development. The New Wealth of Nations must place man at the center not money or markets or even technology, all of which are derivations.

Full Employment

In a report to the Club of Rome entitled the The Employment Dilemma: The Future of Work, Orio Gianini and Patrick Liedtke call for new economic theory on employment in order to fulfill Adam Smith’s dream of the Wealth of Nations. In formulating new theory, it is both common sense and good ethics to start with the premise that any system which purports to represent sound economics must provide a viable means for all members of society to acquire at least the minimum (why not the optimum?) level of purchasing power needed for survival, development and full enjoyment of their human potential. If economic systems based on current economic theory are unable to provide sufficient employment opportunities, it means either the prevailing theory or its application are deficient. In the absence of such opportunities, society must provide adequate support for all its members in the form of social welfare benefits. There is no inherent reason why we cannot devise an economic system in which everyone that is willing to work and capable of productive activity is assured of an opportunity and means to do so. There is a great deal of work that is not getting done in the world, work that would raise the other half of humanity to middle class status. In addition, humanity has an insatiable appetite for more education at all levels, improved health care, more and better attention to the needs of children and the aged, better community development, more research, new forms of entertainment, infrastructure improvements, etc. So we have a vastly underutilized resource and plethora of unmet social needs. This requires formulation of new theory based on the premise that all members of society have a right to employment, a theory that not only affirms the right but also presents the structures and processes by which this can be achieved. So long as employment remains the principle means by which people acquire the money needed for the goods and services they need for survival and welfare, access to employment has to be considered a fundamental human right.

Problem of Value

Advances in theory and measurement must necessarily proceed hand in hand. In Limits to Uncertainty, Orio Gianini highlights fundamental differences between the industrial model of economy that emerged with the Industrial Revolution and the modern service economy that has emerged post 1970, demonstrating that methods used for measuring the value of manufactured goods are inappropriate for measuring the value of many types of services. As the recent financial crisis so dramatically illustrates, the new economy involves new types of risk and far greater degrees of complexity, vulnerability and uncertainty. In contrast to the traditional economic model which equates price with value, in the service economy, contractual obligations of the seller and the uncertainties of the buyer extend long after the date of sale, throughout the entire life cycle of utilization and even disposal. Evolving measures to adequately reflect risk and uncertainty represents a formidable challenge.

Furthermore, the monetized economy represents only a portion of human activity directed to promote welfare and well-being. Until 1800 more than 50% of all economically productive activity was self-production for self-consumption or barter, occurring without monetary exchange. Even today monetary transactions represent only a limited portion of what truly characterizes the wealth of nations. Ecological resources are a good example of non-monetized aspects of wealth. Both unmonetized and non-monetarized wealth are inadequately accounted for by traditional economic theory.

Indicators of Human Welfare

Right measurement is a powerful instrument for social progress, wrong or imprecise measurement a source of hazard and even havoc. The efficacy of modern medicine depends on the crucial role of precise measurement in modern medical diagnosis is illustrative. Today there is an urgent need for more effective economic indicators to guide policy and decision-making. The essential purpose of economic activity is not growth for growth’s sake, but rather the promotion of human development, welfare and well-being in a sustainable manner. The challenge is to derive more appropriate indicators to reflect real, sustainable economic welfare, social development and human well-being.

The deficiencies of GDP as a measure are well-documented, but the attributes that have made it so successful are often overlooked. The challenge is to derive more appropriate indicators to reflect real, sustainable economic welfare, social development and human well-being. Many commendable efforts are underway to formulate new composite measures of social progress, but in an effort to be both comprehensive and precise, they often sacrifice the clarity and utility of existing measures. The authors have formulated a new Human Economic Welfare Index (HEWI) that seeks to retain the strengths associated with GDP, while substantially enhancing its value as a measure of human economic development. HEWI monitors progress on five essential components of sustainable economic welfare – household consumption and savings, income distribution, employment, education and fossil fuel energy efficiency. The index has been applied to assess the economic performance of select countries from 1980-2005.

Human Economy

Economy began as a subset of political science before becoming an independent branch of study. Today the shift needed is an evolution from market and financial economics to social economics founded on the wider productive potential of society as a whole and a shift to human-economics founded on the unlimited potential of the individual human being for increasing productivity and resourcefulness. As Willy Brandt said, “Problems created by man can be solved by man.” The economic problems humanity confronts today are well within our capacity to resolve. Effective solutions require a new and wider perspective.

 


[*] Based on “Introductory Paper for A program on The Wealth of Nations Revisited” by Orio Giarini, Garry Jacobs, Bernard Lietaer and Ivo Slaus, and “Indicators of Progress: The Power of Measurement and Human Welfare” by Garry Jacobs and Ivo Slaus, Cadmus Journal, Vol.1, No.1, October 2010, www.cadmusjournal.org.

[†] The authors are members of the Board of Trustees, World Academy of Art & Science

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