What goes wrong?

Criticisms & Caveats
The story so far has laid the economic groundwork for some of the processes of globalisation. However, it is clear both that things go wrong, and that not everyone is convinced that 'all is for the best in this best of all possible worlds'. One of the most pungent and well-informed criticisms, especially of the IMF, is the recent book by Jo Stigletz (a winner of the Nobel Prize for Economics), who was Chair of the US Council of Economic Advisors to the US President, 1993 - 1997; Chief Economist, and Senior Vice President at the World Bank, 1997 - 2000):  Globalisation and its Critics.  This book chronicles what Stiglitz sees as the major shortcomings of, especially,  the IMF's behaviour and operation, especially with respect to the Asian Crisis (when a number of Pacific Rim countries suffered major economic crisis beginning in 1997), and to  the liberalisation programmes followed in Russia following the collapse of the Berlin Wall.

The major shortcomings of the framework so far outlined can be grouped under three major headings  (not so identified by Stiglitz, though frequently illustrated by his accounts):
  1. Economic Caveats
  2. Institutional & Political Failures - the rules and conventions of the game.
  3. Organisational Failures.
1.    Economic Caveats
a)    What the Free Market CANNOT deliver

Institutional Framework:  The textbook free market (specialisation and trade) requires that there is a socio-economic foundation of accepted norms, rules, codes and conventions (North and Williamson etc. call these things 'institutions) which both accept and support the activities of private enterprise in seeking to provide what the market (consumers) require and are prepared to pay for.   of the market (which is supposed to ensure that no one can be made better off without making someone else worse off - the Pareto welfare criterion). Common law (government) needs to provide:
The lack of a well developed institutional infrastructure to support markets is bound to lead to substantial misfunction, if not outright disaster. With no effective laws and associated police and judicial systems, contracts will not be honoured, property will be stolen, funds mis-appropriated - the market system will fail.  Many of the difficulties experienced in the liberalisation of the former Soviet Union were to be expected in the absence of these vital institutions (and the associated lack of any common social acceptance of and legitimacy for the market system). Russia itself was always going  to be especially problematic, since it had never operated effectively as a market system (unlike most the Central and Eastern European satelites) having been dragged almost directly from a Feudal system by the Communist Revolution in 1917.  There was no folk memory or history of market systems to draw on in Russia, whereas there was in the Central European countries.

Equitable Outcomes:  The free market relies on the pursuit of self-interest - profits and earnings to make a living, and consumption spending to have a life. The workings of the system practically guarantee that incomes (and especially wealth - see below) will become concentrated - those that do best will prosper more than those who do not, and will manage to pass on their gains to their heirs and successors. Even in the most equitable world possible, the simple necessities of providing for childhood and old age would ensure some significant concentration of wealth (savings).  Suppose that everyone earns the same wage, and that this wage stays constant throughout the working life (21 - 60), and that everyone lives to be 70, and that everyone is responsible for providing  for the upkeep of one child (their replacement!), and their own retirement (at the same level of consumption as everyone else). Ignoring any compound interest, the necessary savings to finance this entirely equitable system would concentrate 50% of the population's wealth in less than 30% of the people, and  30% of the wealth in less than 20% of the people.

In practice, the pursuit of self-interest rewards the innovative (and lucky) more than the also rans, and the  protection of private property ensures that these gains will be largely preserved (unless dissipated by either altruistic patriarchs or stupid and incompetent successors).

Furthermore, nothing in the free market guarantees that the initial endowment of the factors of production (land; labour skills, expertise, capacity; capital or management) of people will be equitable. The free market is only efficient (could not be bettered in the Pareto sense) in using these resources given their initial distribution amongst the population.  This initial distribution (whenever we decide this should be) will not be equitable.  Those with few resources (low education, little or no capital, no land) are likely to remain poor, while those unable to contribute to the economy, for whatever reason, will be destitute.

Civilised societies recognise this, and do something about it through their governments. Approximately half the total tax revenues raised by the UK government are used to support the less well-off in one form or another (pensions, unemployment benefit,  social security etc.) through transfer payments.  Another substantial part of tax  revenues is used to provide merit goods:  especially education and health, where ability to pay is not regarded as an appropriate or civilised way of distributing these goods and services. Another part is used to support local and regional development initiatives (and planning controls), to alter an otherwise free market distribution of development and growth geographically to better meet the wishes of society.

One Person, One Vote:  Market signals are provided by prices - the votes about who gets what and what is produced are pound notes. The rich consumers are necessarily more powerful (as individuals) than the poor, and have more say in the outcomes of the free market. However, as Karl Marx observed, if the rich capitalists only pay attention to their own (rich) needs, which tend to become more concentrated (though see below), then their markets will shrink, and the foundation of their own income and wealth will collapse. So, enlightened markets can be expected to try and develop their own customers, which involves encouraging and  assisting (within reason) as many people as possible to become richer consumers. By the same token, providing there is freedom of complete information (see below), one would expect enlightened firms not to poison or harm their customers (otherwise theywill loose their livelihoods) or to harm their workers (or they loose their capacity to produce).


b)    Market Failures
Economic Textbooks typically list the assumptions of the competitive market to be:
In addition to these typical assumptions of the competitive market as it might be when in equilibrium (balance with the prevailing  conditions), the theory says little or nothing about the costs and difficulties of transition or dynamic change. When trade is opened up between two previously isolated communities, or  within a community previously governed by central planning and command and control systems, competition says that there will have to be substantial resource reallocation - people will have to stop doing what they were doing before, and do something else.  This takes time, effort, and resource, and will  tend to be resisted unless people believe in the benefits. Unless these benefits are quickly apparent,  credibility and legitimacy of the reforms and liberalisation are likely to be resisted. It is not hard to believe that many in Russia remain to be convinced that either the market system is demonstrably better than the previous Communist system, or that the process of liberalisation is not simply a backdoor method by which the rich and powerful (especially the US) can take control of their lives.

c)    Economic Malfunctions
Management of whole economies through appropriate fiscal and monetary policies remains an inexact science. It is tempting to presume that the simple macroeconomic models (as outlined in the previous session) are good representations of reality:  capital flows and their control vital: see here

A key phenomenon to understand here is Capitalism - this goes one very considerable step further than the story of economic competition, trade and specialisation outlined in session 2 above, though this fact is seldom recognised in most textbooks.


2.    Institutional & Political Failures

3.    Organisational Failure

http://www.cedu.niu.edu/~fulmer/groupthink.htm