Back to the Future: Economics for the Real World
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A second vital contribution, now forgotten, came from American “institutional” economists who emphasized the significance of the nature of competition. The most famous living proponent of this American school is John Kenneth Galbraith. Whereas Keynes’s analysis gave birth to the modern field of macroeconomics, American institutionalists focused on the microeconomic failings of the system. These failings were framed in terms of the “competitive menace,” a notion that echoes today’s concept of the race to the bottom — epitomized by Wal-Mart.
Institutionalists did not challenge the idea that self-interest and profit are major motives for economic action, but they did recognize that their pursuit could lead to sub-optimal outcomes. What appears to maximize well-being from an individual perspective can be sub-optimal once the competitive inter-play of actions is taken into account. Thus, when Wal-Mart refuses to pay health benefits, other retailers are forced to go in this direction to remain competitive and survive. Likewise, when Wal-Mart sources globally, so too must other retailers. The result is erosion of American manufacturing jobs and wages. Nor do wages rise in developing countries because Wal-Mart plays them off against China.
Such a perspective leads to the idea of “regimes of competition,” and policy should aim to create a competitive environment in which working families prosper. The challenge is to design regulatory institutions (regimes) that balance the Keynesian need for stable flows of demand and income with the capitalist need for economic incentives. Such market regulation prevents excessive price fluctuations, and also prevents the kinds of pre-Depression monopoly and exploitation that weakened America’s income and spending base.
The New Deal embodied much institutionalist policy in the form of laws establishing a minimum wage, the forty-hour week, the right to overtime, and the right to join unions. These labor laws complemented consumer product safety laws. The New Deal also introduced law regulating financial markets, which paired with earlier legislation establishing the Federal Reserve as regulator of the banking system. Together, these regulations established an economic regime that excluded destructive competition, ensured a “Henry Ford” distribution of income whereby workers could buy the things they produced, and prevented market tendencies to deflation.
Viewed in this light, American institutionalism provided a new microeconomic thinking that paired logically with Keynes’ macroeconomic analysis. Keynesian monetary and fiscal policies stabilized the business cycle, while institutionalist market regulation built the middle class, and together they underwrote the great prosperity of the post-World War II era.
However, even as these policies were being put into practice, they were being driven out of economics classrooms and textbooks. Whereas Keynesianism won mainstream standing, its microeconomic counterpart never did. One reason was institutionalism’s focus on capitalism’s crueler failings, which was politically unacceptable in the Cold War era of geo-political competition. This meant institutionalism was driven out of classrooms by the end of the 1950s, which meant it was driven out of policy shops and legislative chambers by the end of the 1970s.
Globalization has again raised the specter of destructive competition, calling for a resurgence of institutionalist thinking. However, such thinking is now barred and obliterated by post-Cold War, free-market triumphalism.
This has enormous practical and political consequences. Absent the one-two combination of Keynesianism and institutionalism, globalization will likely stumble badly. Similarly, well-intentioned progressive politicians in America and Europe, looking to tackle the problems of globalization, will find themselves lost as long as they adhere to the laissez-faire thinking that dominates universities.
This risks making progressives irrelevant for economic policy. In the 1930s, the economics of the day proved not up to the challenge of the Great Depression, forcing the development of new economic ideas. The same holds today for globalization.
This article first appeared at www.thomaspalley.com.
Thomas Palley was formerly Chief Economist of the US–China Economic and Security Review Commission. He's the author of Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianismand Post Keynesian Economics.
