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Towards a ‘New Economics’: Values, Resources, Money, Markets, Growth and Policy

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Abstract

‘New economics’, as outlined in this chapter, is developed from the Post Keynesian approach to macroeconomics to allow for intrinsic values, institutional change and diverse consumers and producers. The chapter presents a self-evident set of assumptions on which to base the theory and then develops an analysis of demand-driven markets within a historical process of globalisation. The asymmetry between consumption and production is emphasised, with production being concentrated and preceding consumption, but consumption being more generalised and causing production. A theory of economic growth through endogenous technological change and increasing trade is presented. Fiscal policies and regulation, with incomes policies, are required to manage the system to achieve full employment, with monetary policies accommodating demand for money. The chapter concludes with a discussion of the quantitative modelling at the global level to represent the economic system in accordance with the theory.
1
This is a pre-publication copy of a paper published as:
Barker, Terry (2011) ‘Towards a ‘new economics’: values,
resources, money, markets, growth and policy’, chapter 2,
pp. 39-76 in Philip Arestis and Malcolm Sawyer (eds) New
Economics as Mainstream Economics, Palgrave
Macmillan, 2011.
Towards a ‘New Economics’:
values, resources, money, markets, growth and
policy1
Terry Barker, University of Cambridge
Abstract
‘New economics’, as outlined in this chapter, is developed from the
Post Keynesian approach to macroeconomics to allow for intrinsic
values, institutional change and diverse consumers and producers.
The chapter presents a self-evident set of assumptions on which to
base the theory and then develops an analysis of demand-driven
markets within a historical process of globalisation. The asymmetry
between consumption and production is emphasised, with
production being concentrated and preceding consumption, but
consumption being more generalised and causing production. A
theory of economic growth through endogenous technological
change and increasing trade is presented. Fiscal policies and
regulation, with incomes policies, are required to manage the system
to achieve full employment, with monetary policies accommodating
demand for money. The chapter concludes with a discussion of the
quantitative modelling at the global level to represent the economic
system in accordance with the theory.
Keywords: new economics; Post Keynesian economics; endogenous
technological change; demand-led growth
JEL Classifications: A13, B52, E02
1 Thanks to contributors to the 2010 Bilbao conference of Post Keynesian
Economics, as well as David Taylor, Serban Scrieciu and Richard Lewney
for comments. Thanks are also due to The Three Guineas Trust, one of the
Sainsbury Family Trusts, and to the Cambridge Trust for New Thinking in
Economics for financial support.
Towards a New Economics
2
1. Introduction
The climate and financial crises have shown the inadequacies
of traditional thinking in economics and encouraged new
approaches to understanding economic behaviour. New
thinking in economics is an interdisciplinary approach to
economic problems that acknowledges and respects the
insights and analysis from other disciplines, especially those
from ethics, history and engineering as well as institutional,
complexity and evolutionary theory. The economic system
embedded in human society is non-linear and complex.
This chapter proposes some theoretical foundations for
such a new economics, drawing on and developing the Post
Keynesian approach to macroeconomics and including strands of
institutional, evolutionary and ecological economics. It starts
with a discussion of the antecedents in the literature and proposes
some defining features of new economics. The chapter continues
with a consideration of ethics and an assertion that intrinsic
values are distinct from monetary values and should not
generally be converted to them. It then introduces resources,
including people and institutions. The role of money as a critical
economic resource is discussed. It sets out some assumptions to
provide the theoretical basis for the understanding of the
economic system. Markets and growth in trade and output are
treated as emergent properties of a complex economic system in
which money allows the specialisation of production and the
generalisation of consumption across regional and national
boundaries over time. Technological change is intrinsic to the
process. Policy is required to manage externalities and impose
social values.
The theory has been developed in parallel with the
construction and application of large-scale computable models
of the economy. The representation of the system is limited by
the data, but it follows the theory in that it is structural, path-
dependent and allows for different responses by institutional
categories. The modelling of the system is intended to be
forward-looking, projecting the outcomes evident in the past
into the future. The models are policy-oriented, designed to
assess how portfolios of national and international policies, for
example those for mitigating climate change, can achieve their
objectives efficiently, effectively and equitably. Models have
been developed to simulate behaviour of industries and
consumers at different spatial scales (UK, Europe, and the
Towards a ‘New Economics
3
world) over the period since 1970, using computing algorithms
to solve the systems of equations.
2. Antecedents of New Economics2
New economics is generally associated with Keynesian
economics, the ‘new’
3
being in contrast with the neoclassical,
traditional economics, with its emphasis on equilibrium,
mathematical formalisation and deterministic solutions. Here the
term ‘new’ is being used to cover several approaches that oppose
this traditional economics, including Post Keynesian,
institutional and evolutionary economics and allowing for
complexity theory. Holt (2007) characterises Post Keynesian
economics by four features: (1) a commitment to understanding
how actual market economies function in historical time,
providing explanations of observed economic behaviour; (2) a
recognition of the irreversibility of events in historical time or
‘path dependence’, which makes equilibrium problematic as an
organising concept; (3) a crucial role for uncertainty and
expectations in the theory, with deep uncertainty and outcomes
that cannot be predicted; (4) an emphasis on the role of
institutions in shaping and channelling economic behaviour.
These features are also those, with a different emphasis on each,
of institutionalist and evolutionary economics.
This new economics is in contrast with what might be called
traditional economics, based on the neoclassical mathematical
synthesis promoted by Samuelson (1947) that came to dominate
mainstream economics thinking in the late 20thC. Traditional
economics has been defined as “the set of concepts and theories
articulated in ... textbooks. It also includes concepts and theories
that peer-reviewed surveys claim, or assume, that the field
generally agrees on.” (Beinhocker, 2006, p. 24). This traditional
economics is characterized by an emphasis on rationality, via
the use of utility maximization in conditions of equilibrium,
and by neglect of strong kinds of uncertainty, particularly of
fundamental uncertainty (Dequech, 2008, p. 290). The
approach adopts a version of expected utility theory with human
2 Barker (2008) develops many of the ideas summarised in this and the next
section, but in the context of climate change economics.
3 The term ‘New Economics’ has been used since the 1940s to refer to
Keynes’ approach to economics and later to the Keynesian approach e.g. in the
title of Harris’s edited book originally published in 1947. The book provides a
comprehensive review and critique of Keynes’s work (Harris, 2005). Then, as
now, ‘new’ is to be contrasted with ‘traditional’, but now traditional
economics has incorporated a synthesis of Keynesian and neoclassical theory
(e.g. in New Keynesian macroeconomics).
Towards a New Economics
4
welfare usually translating into private market consumption per
head in the applied models. The theory is applied to utility across
countries with huge differences in consumption and to utility
gained many years into the future, when consumption can rise
perhaps many times over.
This traditional approach to economics has largely ignored
other disciplines tackling the same problems of justifying
assumptions and understanding human behaviour. In particular,
the study of ethics considers utility theory and social justice,
exploring the limitations and contradictions in utility
maximisation (see Ackerman and Nadal, 2004) and providing
alternatives. Engineering and architecture give insights into how
the equipment and buildings can be designed to save energy.
Economic geography and history provides understanding as to
how economies grow and how technologies diffuse and evolve.
Political science considers how societies make decisions
regarding public policy. Furthermore, economics is not confined
to the study of equilibrium in various guises, assuming groups of
identical representative agents, with entirely self-interested
consumers and known, quantifiable social welfare functions.
The weakening of the neoclassical paradigm has been
accompanied by a more general undermining of the ideology and
prescriptions of traditional economics by deconstruction of the
origins of the theory in physics and cybernetics (Mirowski, 1989,
2002). Behavioural economics going back to Kahneman and
Tversky (1989) has revealed key relevant empirical findings for
risk aversion and utility maximisation that are inconsistent with
traditional treatments. Complexity theory and agent-based
modelling has developed a theory of economic evolution
(Arthur, 1994; Beinhocker, 2006). The new economics is more
pluralistic and respectful of other disciplines. Cost-benefit
analysis is formally replaced by a Multi-Criteria Analysis
developed in management science and applied to sustainable
development (Munda, 2005) in which socio-economic,
ecological, and ethical perspectives are taken into account.
In the debate as to what has become mainstream economics,
it seems agreed that the traditional neoclassical approach has
become less influential, but it is not clear what has taken its
place (Colander et al., 2004, Dequech, 2007). Hodgson (2007)
speculates whether institutional and evolutionary economics has
become the new mainstream. In climate-change economics, the
Stern Review appears to have shifted the mainstream away
Towards a ‘New Economics
5
from the traditional neoclassical approach to a more pluralist,
risk-based approach (Stern, 2007).
One aspect of the shift in the mainstream is a debate on the
ethics underlying traditional prescriptions, particularly in climate
policy. Utility maximisation as a method rests on the idea that
individual preferences are fixed and utilities can be aggregated
and converted into well-behaved mathematical equations in a
“social welfare function”, and differentiated to give stable
marginal properties, as the basis for policy. In climate policy,
this approach leads to utilities being aggregated and discounted
over generations, and social choices involving irreversible and
substantial losses of ecosystems and human lives. Such
implications raise ethical problems that have led to a questioning
of the underlying value system in the traditional approach
(Maréchal, 2007, Barker, 2008). The next section reviews the
values that should underlie economics.
3. Values in New Economics
Many issues of economic policy (traditionally called “welfare
economics”) are primarily ethical in nature, and should be
informed by moral philosophy rather than economics in
isolation. Intrinsic values are distinct from monetary values and
should not generally be converted to them. Traditional economic
models adopt an extreme form of utilitarianism, with a
questionable choice and use of discount rates, ignoring the
philosophical literature and the concept of justice.
Moral philosophers have long debated the relative weighting
to be given in utility theory between social groups. Broome
(2006) insists that economics is not ethics-free, that basing
economics on the ethics of individuals assumed to be entirely
self interested can go badly wrong, and that “willingness to pay”
is invalid as a means of valuation (Broome, 2005). In economic
analysis, justice as a theory of ethics (Rawls, 1971) deserves
serious attention as an alternative to utilitarianism. Rawlsian
ethics would focus social policy on preventing the harm and
damage to the most vulnerable in society and on caring for the
subsistence minority of developing countries, unlike the
traditional policies, which have focused on averages and set
aside problems of inequality.
Traditional economists assume fungibility of natural and
human-made assets, i.e. that they all have monetary values and
Towards a New Economics
6
can be exchanged. This is economics as a religion (Nelson,
2001), in which society is composed of self-interested
individuals, whose behaviour is to be assumed rational, then
interpreted and described by economics as a mathematical
science, e.g. in finding and using the pure rate of time preference,
or the value of human life. The underlying fallacy is that market
forces lead by themselves to intrinsically good outcomes (Foley,
2006).
A new economics approach is to acknowledge that there are
ethical, aesthetic and other values, and that resources seen to
have intrinsic value should not routinely be converted into
money, with the exchangeability that money permits (Ackerman
and Heinzerling, 2004, Gowdy, 2005). The use of the discount
rate to account for time preference and risk should be re-thought
to allow for subjective time preference and a risk analysis
independent of the return (Price, 2005). The distribution of rights
consistent with sustainable development should be considered
(Padilla, 2004). These considerations suggest that it is necessary
to go back to the treatment of resource allocation by institutions,
to allow for the evolution of diverse social valuations of
resources. The next section bridges the divide between micro
and macro economics in the treatment of resources and
establishes a basis for macroeconomic analysis that does not
involve the aggregation of representative agents.
4. Resources, including Institutions, in Space and
Time
Economic activity requires resources, including people,
institutions, knowledge as well as things, and takes place in
specific locations at particular times. Space and time are
fundamental categories in any attempt to explain the world:
first, they are universal; second, they are essential features of
physical and economic laws; and third, they are required for
causation. People and objects must be in contact or
communication with each other across space if they are to
interact; and the arrow of time requires that causation goes one
way only, from the past to the future. The treatment of space
and time is therefore fundamental in economics and the social
sciences4
4 See Barker (1996) for more details. Faden (1977, p. 10-11) starts from this
point. Isard and Liossatos (1979, chapter 2) discuss perceptively the
.
Towards a ‘New Economics
7
4.1 Institutions and Evolution
People live and interact in social groups each with their
characteristic institutional rules and behaviours. These social
groups or organisations, with a life of their own, provide a
context which shapes and guides economic life. They are
essential in providing the framework that governs economic
behaviour. Each group or organisation has its own places and
its own history, each has its own birth and death, each has its
own institutional habits, procedures, ways of being, objectives,
motivations and in the case of companies, corporations,
schools, and many other groups, laws imposing duties and
responsibilities. In modelling these groups, a balance has to be
struck between the integrity of the group, the differences
between groups and the multiplication of groups making the
analysis unmanageable.
Institutions are fundamental to economic life and
human society (Veblen, 1899; Commons, 1934; Sowell, 1967;
Coase, 1988; Samuels, 1989; Williamson and Winter, 1991;
Hodgson, 1999). Several institutional social groups would
appear to go back through all human history since they exist in
other, closely related, animal societies (e.g. all primates have
the family, and the tribe or the village). Such
institutionalisation, therefore, goes back into human
evolutionary past. The rules and procedures associated with
social groups are embedded deep within human
conceptualisation of the world and are associated with
instinctive behaviours with regard to individual and group
behaviour for everyday living and long-term survival.
Understanding economic behaviour involves understanding
these instinctive responses and reactions in social and
institutional contexts.
4.2 The Economic Characteristics of Products
Characteristics of products can be distinguished from the
products themselves. A product is a collection of goods and
services, normally goods or services, having similar
combinations of characteristics. Characteristics can be
defined, following Lancaster’s work (1971), as ‘properties of
people, institutions and resources, (such as products) that are
relevant to the economic activities of people and social
various intuitive notions of time and its interrelation with space, but without
any emphasis on the role of institutions.
Towards a New Economics
8
groups’5.
A unit-service is non-material with otherwise the same
definition as a good. A replicated service is distinct from a
replicated good because it must last for a period of time
(material goods obviously have the property of persisting over
time) and it is more liable to change through space and time
(the good comes into existence at an instant of time and
usually remains invariant through space and time). Goods are
one type of ‘particle’ in economics; the unit-service in the form
for example of the availability of a telephone connection or an
attractive park might be seen as another type. Markets are
locations in economic space-time where products are
exchanged. The definitions of a product and a market are
necessarily rather fuzzy because they are intended to match
definitions in official statistics. Products can be identified with
groups by conventional classifications
Examples of characteristics of goods are volume,
calories, availability, colour and many other properties that
enter the choice made between alternative goods. Two
important and obvious characteristics of goods are where they
are located (space) and when they are available to buy or sell
or use or enjoy (time). A good is defined as a material object
with the property that two equal quantities of it are completely
equivalent with respect to all characteristics for each seller and
each buyer. Thus the quantity of a good bought and sold in a
transaction will consist of a number of ‘replicated units’ of the
good. In some markets there is, strictly speaking, only one
such unit on offer, for example in the housing market each
house is unique with respect to its location; in other markets
there are large numbers of such units, as in the case of
manufactured foods.
The price of a good has a singular and identifiable
meaning only at the level of the replicated unit. A breakdown
of the price of such a unit in terms of the characteristics of the
good may be possible by hedonic functions or regression
analysis (see Griliches, 1971). However it is critical to the
theory below that the characteristics are not obtainable
5 Lancaster’s own definition is more restricted in that he defines
characteristics as ‘those objective properties of things that are relevant to
choice by people’ (1971, p. 6). He considers a model of final consumer
demand where a continuous range of alternative combinations of
characteristics is available (he needs continuity for his mathematics); in
what follows, markets are defined for purchasers in general in which only
limited numbers of alternative combinations are available.
Towards a ‘New Economics
9
independently, but only in a finite number of fixed
combinations.
4.3 Externalities and Institutions
Externalities are defined by boundaries, so economic
externalities are those external to the economic system,
although most become internalitiesif we consider the whole
system of the interacting planetary ecosystems, climate and
human economy. Externalities are extensive and pervasive,
and affect virtually every area of economic life. The fact that
this may not be very apparent is simply because institutions,
laws and rules have evolved to restrict most of these
externalities, turn them into internalities, and contain them
within respectable limits (Ostrom, 1990). Mechanisms are
brought to bear that will cut down the externality, either by
reducing the originating activity (‘passive abatement’), or by
introducing a new activity (‘active abatement’ such as end-of-
pipe equipment to remove a polluting emission). If the latter,
the same originating activity takes place, but the new activity
of abatement lessens the effect outside the space-time region in
which it originates, and insofar as any costs of the abatement
are borne by the polluter, this might at least be an equitable
solution, if not an efficient one.
A problematic form of externality is that in which the
damage may be so small or its cause so uncertain that it is
expensive or difficult to establish the property rights of those
who are damaged. In these cases it is difficult to
institutionalise the externality leaving it unclear who manages
it, and who is responsible for it.
4.4 Technology and Economies of Specialisation
Technology is the application of knowledge to the making of
products. The existence and growth of technical knowledge
provides growing opportunities for consumers to discover new
products and new varieties of old ones and firms to supply
them. It allows firms to develop and exploit new or improved
process technologies and economies of specialisation and scale
in reducing costs. In that technology responds to economic
signals, e.g. higher real prices of carbon leading to lower-
Towards a New Economics
10
carbon intensities in production processes, it is an intrinsic
aspect of economic growth6
.
Economies of specialisation relate to social groups, usually
firms, specialising in a particular niche market in order to
exploit technologies and the economies of scale (discussed
below) applicable to that niche. They involve specialisation in
particular skills, expertise, knowledge and information on
special places, products, and markets. Young (1928) ascribes
great importance to these economies of specialisation, which
he calls ‘roundabout methods of production and the division of
labour among industries’ (p. 529). He distinguishes these
economies from those discussed by Adam Smith, when
arguing that the division of labour leads to invention because
workers involved in specialised production see better ways of
doing things. (Smith’s workers could be seeing new
techniques, new management, and larger economies of
specialisation or economies of scale of all sorts.) Young argues
that with the division of labour and the use of machinery ‘a
group of complex processes is transformed into a succession of
simpler processes’ (p. 530). This phenomenon is associated
with ‘large’ production - and hence the extent of the market is
to be distinguished from that of ‘large-scale’ production, i.e.
economies of scale (p. 531).
4.5 Integralities and Evolution
The concept of ‘integrality’ or indivisibility is inherent in a
human understanding of the world, since as far as each of us is
concerned our bodies are indivisible. And since the human
body and many of the tools and other objects around us are
integral (if they were divided they would lose their function) it
seems reasonable to speculate that human conceptualisation
and ‘views of the world’ are deeply influenced by this
property. The combination of integralities and increasing
returns has led to a uniformity in the buildings, vehicles and
other objects designed and built for human use; door height,
chair size, the shape of a spoon have all ‘evolved’ for human
beings as if we were a homogeneous group.
It seems also likely that we have evolved to work
together in the face of integralities and to develop institutions
to share out the resources. Money is a resource, which is
6 Computable general equilibrium models have traditionally treated
technological change as autonomous.
Towards a ‘New Economics
11
divisible in order to allow exchange with integral goods and
services of any value. This relates to the question of equity
between members of a social group - a basic feature of an
institutional group is how benefits and costs are shared
between members of the group. Money is also essential in the
process of separating production from consumption that is at
the heart of economic growth because it allows economies of
specialization and scale to be realized. One social group,
namely the banking community, has as its main function the
creation and management of money in the economy. The next
section considers in more depth the importance of money.
5. Usefulness of Money7
Money can be defined as a ‘resource with a set of
characteristics that are embodied in different combinations in
monetary assets’; examples of such assets are notes and coin,
bank deposits, credit and debit cards, bank loans and various
government-backed, short-term bills of exchange. The
important distinction between the characteristics of money or
its ‘essence’ on the one hand, and the forms of money or
monetary assets on the other, was clearly set out by Simmel in
1900 (1978 translation, pp. 119–120), who also emphasized
the innumerable errors that arise if this basic distinction is
not made.
8
The characteristics that form the set that describe ‘perfect
money’ include the following seven distinct items.
1. complete trustworthiness
2. perfect divisibility
3. complete invariance over space and time
4. complete limitation of supply
5. complete acceptance as a unit of account or numeraire
6. perfect convenience as a means of exchange
7 This discussion is drawn from (Barker, 2010).
8 The neoclassical approach to money, based on the quantity theory of
money, does not make this distinction.
Towards a New Economics
12
7. attractiveness as a physical object, or as an immaterial
form of money, e.g. credit cards.
Although we think of money in physical terms - gold,
silver, notes and coins - it is the services that monetary assets
offer that are important, not their physical form. Most of these
services are yielded when money is exchanged, but one of
these services (money as a unit of account) is a general service
yielded through time, allowing the valuation of all goods and
all other services in an economy. There is no single asset that
embodies all the characteristics of money. The implication is
that the money supply is endogenous and uncertain. Money
demand is derived from the desire of holders of money in all
its forms for liquidity. Banks provide liquidity in exchange for
returns from bank lending for financial or real investment, or
speculation, so the desire for loans then leads to the banks
supplying loans. The loans thereby create money as a systemic
property in that social groups taking out bank loans then
deposit the money in banks, so that the banks can lend it out
again, all subject to reserve requirements.
6. Proposed Theoretical Foundations for a New
Economics
Several self-evident assumptions are proposed to form the
theoretical basis of understanding economic behaviour and the
economic system. The first five of these assumptions are quite
different from those that have been adopted in traditional
economic analysis, but they are fundamental and it is asserted
that they are obviously true. The last two assumptions concern
motivation and rationality and the approach is more general
than usual.
6.1 All individuals are different.
Each of us occupies a different position in space-time; we are
endowed with different physical characteristics at birth, and
through experience, using our various skills and intelligence,
the individuality of each of us becomes more and more
marked9
9 The assumption that everyone is different does not mean that we are not
equal under the law, or that we do not have equal rights.
. Individuals can be grouped by common
characteristics such as gender, place of dwelling, nationality or
Towards a ‘New Economics
13
social group but this does not mean that they are the same. In
evolutionary theory, the random or contrived differences
within species are essential for selection to work; they are
biological imperatives. That people are different in their
characteristics and behaviour is also true of institutional
groups. All social groups occupy different and precise niches
in economic space-time with different human members,
different names and different objectives. These differences are
a crucial to the economic success of the groups and their
interaction within the economic system.
6.2 All economic activities take place in a particular location
at a specific time. The study of human beings within social
groups located in space and time is at the core of all social
sciences, including economics.
6.3 Externalities are pervasive in economic life. Economic
externalities are effects resulting from activity within the
boundaries of a specific location in economic space-time, but
affecting other locations later in time. Potential externalities
are assumed to be present in all economic activity.
6.4 Non-linearities in the form of indivisibilities and
boundaries in economic space, and discontinuities in economic
time, are intrinsic and normal. Baumol (1987) defines an
indivisible (or integral) good as one that has ‘a minimum size
below which it is unavailable, at least without significant
qualitative change’. All vehicles - such as the motor car, the
railway carriage, the oil tanker, the Jumbo jet - are readily
reducible to integral units. Fixed assets, such as dwellings,
factories, offices, infrastructure such as the Channel Tunnel,
are almost all entirely integral in the sense that if they were to
be divided they would normally lose economic value. At the
macro scale, whole technological systems (such as modern
road transport with substantial network economies) have an
integral quality in that they depend for their viability on a
particular scale and coverage. The dispersion of markets across
space-time, and the tendency to mould the integral good to suit
the single purchase, both ensure that understanding the
implications of indivisibilities is central to understanding the
economic system itself.
6.5 Human beings have evolved within this economic space-
time as social animals in such a way that there is no
‘beginning’; there is no ‘desert island’; there is no start without
a complex set of interacting, evolving social groups such as
households, families or villages. There are many economic
Towards a New Economics
14
activities in animal behaviour that correspond closely to those
in human behaviour, for example, the exchange of gifts, group
organisation as a means to an end, sharing of economic goods
and services within the group, and storage of goods for later
use.
6.6 The economic motivation of most individuals and groups in
a monetary economy can be summarised as ‘more money is
better than less’ within a context of institutional inertia. Given
the monetary motivation, two sets of problems arise both for
the individual and the group. The first is how to behave to
achieve more money, faced with the availability and costs of
information and the costs of decision-making; and the second
is how to allocate the extra resources over time and between
the members of the group. Social groups face the extra
problem that allocation of resources within the group will
affect the group’s motivation and behaviour. The individual or
group may then behave, in ways of increasing complexity,
following the principles of
(1) the simple rule of more is better than less, without
satisficing or maximising, or
(2) ‘satisficing’, in that a want or objective is perceived and
on its attainment the individual or group is satisfied, or
(3) ‘maximising’ in that the individual or social group
reviews all the information available and acts so as to
maximise some objective criterion, such as the profits
of a firm or the real wage rates of trade union members.
Complexity here is measured by the amount of information
needed to allow the motivation to be realised in economic life.
Because of the more general complexities involved in
predicting the future and the cost of obtaining information, the
motive of maximising is the most complex of the three.
Occam's Razor suggests that a less complex behaviour is to be
preferred to a more complex one, other things being equal.
6.7 The behaviour of individuals and social groups is assumed
to be rational in the sense that the means adopted to satisfy
wants or objectives are those of lowest perceived costs,
including the transaction costs of obtaining more information.
These costs can be economic, social, aesthetic, environmental,
religious or ethical; in general it is impossible to reduce all
costs to the purely economic. In addition, the assessment of
minimum costs is itself a decision by the individual or group
that will depend on specific circumstances and may not be
predictable. However, once habits, rules, procedures and laws
Towards a ‘New Economics
15
have been established to achieve wants and objectives, it
becomes rational to follow such habits and rules to avoid
spending time recalculating the best strategy to fulfil those
wants and meeting those objectives. Such habits are most
likely to change at particular times (e.g. during economic and
political crises and revolutions, or on certain critical dates and
events) - these are discontinuities in individual and social
behaviour.
With these concepts and the behavioural and technical
assumptions listed above, we have the basis (in the next
section) for considering the relationship between demand and
supply, both by product market and in aggregate.
7. Demand-driven Markets
The approach is Post Keynesian and intended to be the basis
for large-scale quantitative modelling. The theory can be seen
as complementing the insights of the theory of
transformational growth (Nell, 1998; Argyrous, 1996 and
2002) in as much as it applies to modern capitalist economies.
The theory emphasizes the role of money and finance in
allowing the separation of supply and demand. The growth of
markets can be seen in a historical perspective as a relationship
between households becoming ever more separated from the
complex large-scale production of goods and services, so that
employment is increasingly separated from domestic work and
subsistence farming. Nell explains growth as a historical rather
than an equilibrium phenomenon, explaining how different
systems have evolved into the modern advanced capitalist
economy. Here the additional features of location and timing
are discussed in the context of the modern global economy
with the emergence of China, India and other developing
economies as fast-growing economies, increasingly linked to
the world economy through trade and investment, and a
transformation of the global economy as never seen before.
Markets are areas of economic activity in which goods
and services grouped into products are exchanged. (Products
are collections of goods and services with combinations of
economic characteristics in common.) Markets are
characterized by institutional regularities, taking place at the
same venue, or arranged at customary or advertised venues;
they may take place each day, each week, each year or at other
known times; or they may be continuous, e.g. the world equity
Towards a New Economics
16
market or the telecommunications market. The markets
transmit effects mainly through those activities creating
demand for inputs of materials, fuels and labour, through
wages and prices affecting incomes, and through incomes, in
turn leading to further demands for goods and services. Note
that there are crucial differences between the markets for
labour services and those for products. Mixing them up is an
example of Boulding’s ‘taxonomy as a source of error’ (1992,
chapter 9). People are consumers as well as workers, derive
welfare for working with others, learn by doing and training
and can actively affect production.10
Those who demand and supply, consumers and
producers, buyers and sellers, shoppers and shopkeepers are
dependent on one another but, in some sense, asymmetrical in
location or timing. Each of the two partners in the exchange is
engaged in an asymmetrical dialectic, the asymmetry in
location being very different from that in time; each requires
the other and their motivations, behaviour and activities can
most easily be understood in the light of the asymmetrical
dependency.
7.1 Demand and Supply Asymmetries in Location
The principal asymmetry in location is in spatial distribution;
on the demand side, households, consumers, buyers and
shoppers are generally scattered, and are therefore less
concentrated in economic space than their suppliers. There are
many reasons for this. First, there are many more consuming
than producing economic and social organizations (there are
more people and households than firms and producers).
Second, each final consumer (individual person or household)
generally purchases a small number of each good or service,
while the producers take advantage of economies of scale to
produce a huge number of goods and services at a fast rate and
in long production runs. Third, the consumers’ wants and
tastes are very diverse, with a vast range of requirements and
desires while the producers specialize in niche markets,
producing a small range of each unit, designed to be sold to
large numbers of buyers. Fourth, households choose to locate
for amenity and a variety of other non-economic reasons,
10 In neoclassical economic analysis people are treated as if they are the
services they can perform in the production function. Labour services are
disembodied from the people that produce them and are available in
continuous amounts.
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17
whereas firms are motivated mainly by economic reasons,
including economies of scale in transport and distribution.
Firms, therefore, tend to be located together, clustering
near to transport networks and particular transport nodes in
order that their own goods can be transported cheaply to their
markets while, at the same time, the goods they require for
production, including fuels, raw materials and other goods in
various states of completion, can be brought to the factory;
location near transport nodes also enables their workers to
travel more easily between work and home.
7.2 Demand and Supply Asymmetries in Timing
Economic behaviour is greatly affected by the ‘arrow of time’
(Coveney and Highfield, 1990): time is irreversible, flowing in
one direction only so the past is closed and the future is open.
Since production necessarily precedes - or at most,
accompanies consumption, the two activities are
fundamentally different: those consuming in the present can be
certain of the activities of those producing in the past; but
those producing cannot be certain of the factors affecting
future consumption. It is paradoxical that the direction of
economic causation usually runs opposite to that of time: the
desire of consumers causes goods and services to be produced;
the desire of purchasers causes goods and services to be sold;
the desire of shoppers causes shopkeepers to advertise and sell
particular goods and services. The exception is when
producers innovate and seek to persuade potential consumers
to buy their new products. Schumpeter argued that it is ‘the
producer who as a rule initiates economic change, and
consumers are educated by him if necessary; they are, as it
were, taught to want new things.’ (1934, p 65). However, the
process has to be carefully managed if the producers are to
succeed, because desires cannot be manipulated completely.
Of course the arrow of economic causation does not
contradict the arrow of time. It can be reconciled with the
arrow of time by making the assumption that producers behave
as if they had perfect foresight regarding the desires of
consumers. If this were the case, producers would make
exactly what the consumers of their goods and services wanted
and the direction of economic causation would be
unambiguous - from consumers to producers, even though the
consumption of goods, and services deriving from goods,
necessarily takes place after the goods have been produced. In
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18
fact, successful producers envision consumption of their
products and do their best to make the vision come true.
7.4 The Interconnectedness of Consumption and Production
The processes of consumption and production have reached
extraordinary levels of complexity and sophistication in
modern economies. The basic distinction between consuming
decision-makers (consumers) and producing decision-makers
(producers) is that the consumers’ vision largely ignores, or
takes for granted, the producers’ vision, but the producers’
vision includes as an essential component a projected or
imagined consumers’ vision. When producers envisage the
design of the product, the purchase of the materials, services of
inputs required to produce it, the actual manufacture and then
the sale, they must then envisage the use and consumption of
the product; otherwise they are more likely to be caught out by
changes in tastes, the different desires of new groups of
consumers, or the loss of old groups, and so give opportunities
to competitors to encroach upon their markets.
7.5 Market Clearing
In the case of commodities (which are exchanged for money)
the location and time of sale, defined in legal and institutional
terms, is the defining place and moment in the related visions
of the producer and consumer. Market-clearing requires the
matching of the purchasers’ and sellers’ visions of the goods or
services being bought and sold. These visions derive largely,
and sometimes exclusively (when the purchaser is identified
with the consumer and the seller with the producer), from the
visions of the original producers and of the final consumers.
This matching may well require the purchaser to revise or
compromise his or her vision at the point of sale if the actual
goods or services available do not accord precisely with the
expectations that brought the purchaser to the market in the
first place.
Market clearing is occasionally achieved largely by
price as in the equity or forex financial markets, but more often
in industrial markets the price is set by the producer or seller as
part of the vision, and the consumer accepts or rejects the price
on offer. Market clearing can be partly achieved by the
adjustment by the seller of the characteristics of the goods and
services in order to induce a sale or by the buyer in accepting
what is on offer. Although adjustment in any or all of these
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19
variable characteristics, including price, can lead to market
clearing, complete clearing of the market in the sense of all the
products being sold is not the usual outcome, and normally
surplus goods are left on the shelf or in the warehouse when
the market closes, and ‘surplus’ capacity of the service
provider is left partly unused. If no surplus goods or unused
capacity for service are left, then purchasers are left unsatisfied
and queues are likely to develop, with rationing of all types,
and again the market does not clear.
Although adjustment through price is by its very nature
obvious, advertised and emphasised, it is not nearly as
important as it appears. For many goods and services the
price, occasionally adjusted for general inflation, is kept
constant by the seller for long periods in the expectation that
demand for the good or service in question will change so as to
help clear the market. For example, in the selling of houses
there may be a persistence of high prices that do not clear the
market because the seller still hopes that the demand will
eventually rise sufficiently for the fixed price to be accepted.
7.6 Prices and wage rates
Prices and wage rates emerge from a resolution of conflicting
interests; the expectations of prices and wage rates are in turn
based on past experience. These valuations are social concepts,
and depend, like the acceptance of money, on social agreement
and custom. This is made obvious by comparing valuations or
prices in different cultures and economic systems. For
example, in the People’s Republic of China, the relative values
of goods and services are quite different from those in the
USA. Values in a specific location at a specific time are
influenced by values in adjacent locations and times (the recent
past in the same location and in other regions in the same
industry, and in other industries in the same region). The
valuations are partly trial and error, since both producers and
consumers, and both buyers and sellers, are uncertain as to
what prices are acceptable. The process has to be like this
because producers do not know the extent of the economies of
specialisation and scale they can achieve at a particular set of
prices (this demand may be years in the future at the time the
production facilities are being designed). Market clearing, if it
takes place at all, is by adjustment over a range of variables,
including prices.
It is worth distinguishing between three sets of
valuations, in this extremely relativistic view of valuation.
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20
Market values are the context-specific values that are
manifested in the actual prices of the exchange of goods and
services in the market, and the actual wage rates paid and
received, i.e. exactly what people, households and firms
actually pay, allowing for all discounts, special offers and the
like. Exchange values are actual or imputed market values.
Worth values are purely subjective evaluations by consumers
of goods and services or by employers of employees providing
labour, although they are related to the market value. Social
values are worth values at the social level, taking into account
non-market externalities. These are the values that government
wishes to put on goods and services and employment using
taxes, subsidies and regulation to abate or control the
externalities, allowing for the overall effects on the level of
production, consumption, employment, equity, the
achievement of basic needs, the environment and future
generations.
Worth values and market values are related as follows:
consumers have a notion of intrinsic values that in the case of
marketable goods are associated with, but not identical to,
market values. People and economic organisations repeatedly
assess worth values, which are seen as fair prices or ‘just’
wages, from their observations of market values. Worth values
are consensus valuations, not specific to a location or time,
repeatedly compared with other peoples’ valuations and other
group valuations, repeatedly updated and revised. Normally,
in order to save time and effort and to make sense of the flow
of information, assessments of worth values stay constant for
long periods of time, especially when the overall rate of
inflation is low. It is by comparing worth values with market
values that purchasers decide whether to buy or not.
Worth values are measurable simply by asking people
or organisations to provide valuations of particular items in
contexts which are as non-locational and as non-time-specific
as possible. There is a spectrum of valuations of such items as
bread and milk, all the items that people purchase on a regular
basis, as well as of those items that people dream about and
imagine purchasing, such as cars and houses. These worth
values allow people to say whether items are cheap or
expensive. Some goods and services can be established as
having worth values that are more or less identical to their
market values, a feature of great advantage to the consumer
and sometimes to the producer. For example, the fact that it
costs the same price to send a letter to all parts of a country is
Towards a ‘New Economics
21
normally an indication of this convergence of the market value
and the worth value.
General inflation prevents prices being completely
invariant over time, but the attractions of prices being invariant
across space are such that for many replicated goods, efforts
are made by the producer to standardise the price across a wide
number of locations. This is in spite of the fact that there are
different costs incurred in supplying, for example, replicated
goods to the Highlands of Scotland when they are produced in
London. And the same phenomenon accounts for the desire
for prices to stay constant through time, and hence the dislike
of inflation. Inflation spoils the information content of worth
values and weakens the connection between the worth value
and the market value. It means that consumers must take more
time to learn new prices, and those who do not learn will find
themselves at a disadvantage.
7.7 Asymmetrical Information and Uncertainty
This problem of asymmetrical information is very closely
allied to the general problem of uncertainty both in the minds
of the sellers and in the minds of the buyers as to the value of
the good or service. In addition to the obvious, known and
verifiable characteristics of goods and services - the location of
the sale, the time of the sale, the prices charged by the seller
and offered by the buyer (if it is a double auction market), the
physical characteristics - weight, shape, etc - of the good and
the quality characteristics of the service, there are a number of
characteristics, unknown or guessed at the time of sale, that
will emerge during the subsequent ownership and consumption
of the good or service. Some of these could be classed as
externalities, others as by-products of consumption, eg food
that damages the consumer. It is clear that uncertainties are
pervasive regarding the characteristics of the goods and
services on sale and that there are extensive institutional
procedures and regulations to protect against harmful effects of
hidden characteristics and to put an obligation on the seller not
to sell defective goods, especially those whose defects can be
readily hidden.
This feature (asymmetrical information) explains a
huge body of laws, regulations and procedures, and indeed
institutions, surrounding the quality of goods and services on
sale. It explains the trade-off in terms of the price of second-
hand goods and that of new goods. It explains the creation and
presence of brand names and replicated goods in terms of
Towards a New Economics
22
quality assurance that the characteristics are as advertised, and
that any hidden negative characteristics have been minimised.
It explains the use of guarantees to strengthen further and
enhance the quality of the new good and the importance of
guarantees ensuring that the purchaser has some recourse if he
or she has indeed been misinformed. The uncertainty about
quality means that following the purchase of certain goods and
services, the subsequent location of the purchaser, and indeed
the location of the consumer, is important in relation to the
location of the sale. If something goes wrong, there are
transport and other communication costs that will have to be
borne if the purchaser is to return to the seller. It also explains
why in many markets purchasers and consumers are one and
the same, simply because it is necessary to form a legal
contract between consumer and seller at the point of sale and
therefore, for the contract to be viable there must be this link, a
close identification of purchase with consumption.
8. Economic Growth and Technological Progress
8.1 Technology, Economies of Scale and Economic Growth
Economic historians have long argued that technological
change and economic growth are intimately related (Maddison,
2001) and path dependent (David, 2001). Technological
change, in turn, stems from the exploitation of scientific
discoveries, given the availability of resources and an
institutional structure that encourages innovation and
investment. Nell (1998, pp. 144-148) outlines the evolutionary
processes in what he calls transformational growth. A crucial
feature of markets is that they select and spread innovation
through financing expansion of investment in successful
products. There is a population of firms, households, banks
and other social groups and variation within each group that
allows selection of successful organizational forms, products
and characteristics through competition and emulation. The
basic economic institutions change over time in response to
new technologies, changes in tastes and in availability of
resources.
The effects of technological change spread through the
economy, creating new demands and saving resources in
supply. In their historical account of how firms and industries
innovate and change over time, Freeman and Soete (1997)
emphasise the importance of heterogeneity in sectors and the
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role of niche markets. R&D and innovation is not evenly
spread, but concentrated in successful firms and diffuses
through an evolutionary and competitive process under
uncertainty. Success comes from three important features of
the innovation process (p. 202). First, there is a constant stream
of potential innovations coming from scientific discoveries and
those firms with high R&D and investment are in the best
position to take advantage of them. Second, firms with close
contact with their customers and markets are better able to
recognise new opportunities for products. And third, successful
firms are able to link the new products to the customers needs.
The implication is that economic growth should be modelled
as a dynamic stochastic process with historical and country
detail. Path dependence means that technological advantages
persist over time and become locked into trading patterns.
Technological change can be highly non-linear, depending on
availability of markets, actual and expected changes in prices
and the industrial organisation of the sectors concerned.
A critical feature of this process is increasing returns to
scale. Oulton, in a study of increasing returns in UK
manufacturing 1954-86, starts his paper as follows:
`No-one doubts that economies of scale exist and are
important - generations of economists and engineers have
established this... Similarly, in a broad sense, no-one can
doubt the existence and importance of externalities, of which
the most obvious and economically relevant is the cumulative
nature of scientific and technical knowledge.’ (1996, p. 99)
His study addresses the question of whether industrial
growth is associated with increasing exploitation of economies
of scale. The model is similar to models used by Caballero
and Lyons (1990) and Bartelsman et al (1991) for data on US
manufacturing and (1990) on European manufacturing, and he
reaches similar conclusions for each. The assumptions are
rather implausible, eg assuming that the elasticity of scale and
the effects of externalities are constant though time, but the
conclusions are that economies of scale internal to each
industry are unimportant for growth, but those external to the
industry are significant. In addition, Oulton finds that
increasing returns are a long-run feature of the system.
Studies using panel data on regional manufacturing
have also assessed economics of scale and found increasing
returns. In particular Fingleton and McCombie (1998) found
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24
evidence of substantial returns to scale for EU manufacturing
in estimating an equation based on Verdoorn’s Law (1949).
The estimates of were confirmed for later data 1986-2002 by
Angeriz et al. (2008). The Law asserts that labour productivity
grows with output, through the growth in output, inducing
technological change. The estimates confirm that there is a
correlation between growth in labour productivity and growth
in output, allowing for the fact that productivity is output per
person employed. In employment equations explaining
employment in terms of output, the Law shows up as a
coefficient on output less than one. Typically for cross-section
data on manufacturing across countries, a statistically
significant coefficient of 0.5 is estimated, providing strong
evidence of economies of scale.
8.2 Demand-side Growth
Economic growth involves technological change and the
interaction between the increasing desire for variety or
diversity in consumption on the demand side and increasing
returns and specialisation in production on the supply side. The
theoretical basis of the approach is developed in Post
Keynesian theory where economic growth is demand-led and
supply-constrained (e.g. Setterfield, 2002) both in the short
term and the long term. The demand for products is not
necessarily matched by the supply, so that prices, waiting lists,
stocks and the utilization of capacity can all change to balance
supply and demand. These changes provide signals to the
markets and lead to adjustment of both demand and supply.
Each industry has expectations of a normal rate of growth,
which is affected by the actual rate both in the industry and
across the economy. The ratio of the actual to normal output by
industry will affect investment and employment, hence the
long-run potential output. If expectations are shocked, as in the
financial crisis 2008 with the collapse of the banks, then
governments can influence them by directly stimulating
demand through government spending or indirectly through
tax cuts and investment incentives for the private sector.
Complexity economists (Arthur 1994, Beinhocker
2006) strongly argue for path dependency and increasing
returns. In modelling effects of technological change on long-
run economic growth, the history approach of cumulative
causation fits with the emphasis on increasing returns (Kaldor,
1957, 1972, 1985). “Cumulative causation” refers to a dynamic
institutional process in which various factors combine to create
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25
a vicious or virtual circle to strengthen an initial effect (Berger,
2008). The specific cumulative causation as a feature of
economic development is a feedback process depending on
technological change and increasing returns. Through a shift in
relative costs or prices or the discovery of a new product or
process, growth of demand is encouraged. If the national
market is open to trade, the growth may also be in export
demand. As demand rises and trade expands, increasing returns
lead to lower costs and prices, so further increasing the size of
the market. New opportunities may arise for using the process
or product. Particular regions and sectors develop
differentially, as the growing markets lead to a diffusion of
higher income and employment in the sectors supplying the
original new product or process. The feedback is stronger the
larger the national market and the more open it is to
international trade.
8.3 Economic Growth and Diversity in Consumption
Consider purchasers’ choice when the goods and services are
indivisible and each has a different combination of desired
characteristics. The effects of increasing real per capita
incomes are to increase the variety of goods and services
purchased. Total expenditure allocated by each purchaser to
the market will grow, since all the characteristics are positively
desired, and an increasing proportion of the available goods
become feasible for more and more of the purchasers. In other
words, each purchaser is more able to buy his or her preferred
combination of characteristics as incomes rise over time. The
variety of goods available will increase and demand will be
spread ever more thinly over the various goods on offer.
The theory is supported by cross-section evidence from
the analysis of family budgets, mainly for the spending on food
in developing countries. The first expectation from the theory
is that, in any market, the average price of the goods bought
will increase as real per capita incomes increase, even though
the prices of individual goods remain constant. This positive
‘quality elasticity’ of expenditure with respect to income has
been measured noted in many studies of consumer expenditure
for various countries and products (Prais and Houthakker,
1955; Deaton, 1988, p. 428; Dong and Gould, 2007, p. 268;
Gale and Huang, 2007, p. 18). A second expectation from the
theory is that in any market the variance of prices paid for the
goods on the market will increase as real per capita incomes
increase (because purchases will spread over the available set).
This has been noticed as a problem of heteroscedasticity in the
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26
regression of price on real income (Prais and Houthakker,
1955, pp. 55-57).
8.3 Growth and Trade
The theory also has implications for trade, both domestic and
international. Consider the availability of different varieties of
a product on the international and the domestic markets. The
varieties available on the international market are likely to be
more numerous and more expensive (due to transport and other
costs associated with distance) than those on the domestic
market. The variety hypothesis (Barker, 1977, p. 161) states
that, up to the point of market saturation, increases in real per
capita income cause a greater increase in purchases of
imported goods compared with domestically produced goods.
If real output varies proportionally with real income per capita
then the elasticity of total imports with respect to this income
will be greater than unity. At the limit when incomes are high
enough to buy all the available goods, this elasticity will fall
towards unity.
In contrast to theories that emphasize supply
determination of growth, the theory underlying the variety
hypothesis emphasizes the effects on trade of real income and
its growth. Consider a product, noting now that some of the
constituent homogeneous goods are imported; indeed the fact
that they are imported may be their only distinguishing feature.
Imports tend to be more expensive because of transport and
other costs, and also there are numerically more types of goods
imported than home-produced, even although the quantity
consumed of the imported goods may be much less than that of
the home-produced goods. If the desire for quality, variety and
distinction is linked with the quantity demanded of the
commodity rather than real income in general, then the share
of imports in the demand is positively related to the level of
demand. The proportionate change in imports brought about
by a proportionate unit change in the level of demand is
defined as the ‘demand elasticity’ for imports of the
commodity.
This theory, ceteris paribus, yields the following
hypotheses about these elasticities.
(i) Since in general one country is able to supply only a
small proportion of the possible varieties of a commodity, then
the demand elasticity will be greater than unity. This applies a
fortiori to the total imports of a country.
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27
(ii) The more varieties of a commodity there are available,
the higher the demand elasticity for imports. Economies of
mass production and standardisation militate against the
production of an ever-increasing variety of goods within a
commodity; the fact that a good more exactly meets the desires
of its consumers is outweighed by the increased cost of its
production. Trade, especially international trade, provides a
means of extending the range of economically-produced
varieties of a commodity. In general, higher demand
elasticities are expected for manufactured goods than for
foodstuffs, raw materials or fuels; the elasticity would rise as
the degree of manufacturing rises since the opportunities for
product differentiation also tend to rise. Thus with a uniform
world distribution of natural resources resources, labour and
capital - but not of demands - most trade would be in highly
sophisticated and differentiated manufactures such as
computers and aircraft, and least trade would be in
standardised products such as wheat or crude oil.
Technological progress in this view of the world
economy would show up in higher growth in exports, since
firms would be seeking the widest possible markets for their
more technically advanced or innovative products. Studies of
innovation and export performance using German
microeconomic data come to unambiguous conclusions finding
significant effects and that the direction of causation is from
R&D innovation to export volumes (Lachenmaier and
Wößmann, 2006).
In this open system, economic growth emerges through
technological change and increasing interdependence of
markets. Full employment and an equitable distribution of
income are not guaranteed. Instead, through inertia of
expectations, the world economy will continue to grow (or
contract) until changes are forced by social groups, such as
governments or banks, responding to unacceptable or
unfavorable outcomes, such as inequalities, inflation,
unemployment or bankruptcies.
9. Economic Policy
So far the chapter has been concerned mainly with the problem
of how to abstract from the facts and theories about the
economic system so as to understand the main features that
underlie economic activity. This section addresses the issue of
the role of economic policy in the new economics, which is
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28
essentially characterised by a Keynesian emphasis on the
importance of intervention by governments through monetary,
fiscal and regulatory policies to achieve socially and politically
acceptable outcomes for the economy. Governments usually
have a wide range of instruments at their disposal to achieve
their targets for economic, social and environmental policy.
Governments set the rules for the operation of the market
economy, manage their own spending for the provision of
public services and social transfers, raise taxes and provide
information on the economy. The justification for governments
for this intervention is that the market system without such
management is subject to social, financial and environmental
problems, such as inequality, unemployment, financial risk-
taking, or global warming, i.e. market failures.
9.1 Inequalities
It is clear from international comparisons of inequalities in
income and wealth that great inequalities can exist in market
economies. Inequalities tend to be persistent and to be
associated with many social problems, such as long-term
unemployment and drug abuse. It has long been accepted that
fiscal policy can be progressive, raising proportionally more
taxes from those with more income and wealth and directing
public spending so that it is targeted on those who are most
vulnerable in society. Typically income taxes are progressive
and exemptions and lower rates are included in Value Added
tax (VAT) systems to benefit lower income groups. Fiscal
policy can be complemented by incomes policies, including
minimum wage legislation, to reduce inequalities.
9.2 Market Externalities and System Risks
There are two other classes of market failure, the first, largely
uncontested across schools of economic thought, is that
relating to externalities such as those relating to the natural
environment. The market system relies on the environment to
provide vital services without cost. If these services are limited
in supply, they can be overused and damaged. This market
failure can be addressed by regulation, or by imposing a price
on the use of the service, e.g. a carbon price to discourage the
emissions of CO2 from combustion of fossil fuels. Another
generally agreed market failure relates to the beneficial
externality associated with innovation. An innovating firm can
take out patents and copyright, develop a brand, and impose
other barriers to entry into the market, but it is very difficult to
prevent rivals from taking some benefit from the innovation.
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29
The consequence is that the operation of the market will lead
to a lower level of innovation than is justified by the social
benefit, so providing a case for special treatment of innovation
spending, either a direct subsidy or privileged access to
funding or allowances against tax liabilities. An additional
externality is the systemic risk in the financial markets
associated with long-term speculation on the direction of asset
prices. The risk is that of banking insolvencies as in the 2008
crisis leading to a massive increase in public debt and volatility
in prices and demand.
These externalities justify a portfolio of public policies,
with the mix of regulation, fiscal and monetary policies
depending on the specific conditions and the political stance of
the government. Some of them are intrinsically global issues,
such as climate change and systemic banking risk, and justify
global taxation and regulation, such as international emission
trading scheme and standards for low-carbon equipment.
Policies to reduce the banking risks are regulation and taxation.
The IMF (2010) has proposed a Financial Stability
Contribution (FSC) and Financial Activities Tax (FAT) at the
G20 meeting in June 2010. The FSC is intended to provide
governments with funding to help resolve future crises when a
bank or other financial group is deemed to be too big to fail.
The FSC is a form of insurance payment so that when a bank
failure is threatened, the financial authorities can provide some
value to unsecured creditors and maintain vital services when
equity becomes worthless and management is replaced. The
FAT is a tax, like VAT, on wages and profits, designed to
reduce the size of the financial sector, which is largely VAT
exempt, in relation to other sectors of the economy that pay
VAT. Other externalities also justify specific taxes and
subsidies, such as tax allowances for business spending on
innovation.
The second class of market failure is macroeconomic. Here
there is the likelihood that inconsistencies between desired
investment and saving will lead to excess demand and
inflation, or involuntary unemployment. There is a strong case,
widely accepted, for automatic stabilisers in the fiscal system.
The stabilisers, for example the progressive tax and benefit
systems, allow government expenditures to be maintained
when government revenues fall because of a collapse in
incomes or spending from an unanticipated shock. There is
also a case, less accepted in the literature but central to the
response by governments to the financial crisis of 2008, for
Towards a New Economics
30
interventionist fiscal policy even without the rise in
involuntary unemployment seen in many economies after the
crisis (Arestis and Sawyer, 2003, 2004; Heise, 2009; Fontana,
2009). The traditional view is that of the “New Consensus
Macroeconomics” in which the role for interventionist fiscal
policy is negligible, because it is seen as ineffective though the
response of the private sector, namely that public spending
“crowds out” private spending. Arestis and Sawyer (2003)
comprehensively address the theoretical arguments for
crowding out, including the Ricardian Equivalence Theorem,
and conclude that unless the economy is at full employment
and generating wage inflation there is a role for fiscal policy.
They provide a brief review of the estimates of crowding out in
the literature and conclude that “Fiscal multipliers and other
tests tend to provide favorable evidence for fiscal policy”. (p.
23)
Spilimbergo et al. (2009) provide a more recent review of
empirical estimates of fiscal multipliers and the implicit
crowding out of government-induced increases in investment.
They confirm a repeated finding of substantial differences in
estimates of the fiscal multiplier both across countries, over
time. It is particularly noticeable that different researchers for
the same country and time period can estimate substantially
different multipliers. The main reason for the substantial
difference in long-run multipliers seems to be in the theoretical
approach: New Keynesians and others assuming rational
expectations in the modelling assume no long-run effect, i.e.
full crowding out; those assuming adaptive expectation in a
Keynesian framework, find multipliers above 1. In general, the
multipliers reviewed increase with the economic size of the
region and are largest for globally co-ordinated policies, they
increase over time and they vary according to the source of the
fiscal stimulus.
Official economic policy-making since the 2008
financial crisis in many large economies was initially
dominated by Keynesian thinking, given the widespread
adoption of stimulus packages. There are two aspects of the
procedures that appear to be particularly important. First, the
policies are usually concentrated on macroeconomic variables
such as total private consumption or total investment, almost to
the exclusion of their components; and second, the objectives
of the policies and the consideration of their effects have been
confined mainly to the short-term future, i.e. over the
following 12 to 18 months. The emphasis on macroeconomic
Towards a ‘New Economics
31
variables has its counterpart in the use of hypothetical concepts
such as the ‘non-accelerating-inflation rate of unemployment’
(NAIRU for short). These concepts are used as a guide to the
required changes in policy, but if the changes have important
structural effects then the analyses and policies may result in
departures from the targets in the form of higher
unemployment or extra inflation. The problem is that actual
changes in policy to pursue macroeconomic objectives often
provoke structural effects, thus undermining the very basis of
the policy. Another weakness has been the use of changes in
tax rates and levels of expenditures to meet short-term needs,
with the consequence that policy objectives, which can be
reached only by a medium-term or long-term strategy, come to
be seen as unrealistic and unattainable.
9.3 Aggregation in Economic Modelling
The problem of aggregation arises because all
people and social groups are different, and the
explanation of behaviour at the level of the
individual person or group cannot simply be
aggregated to give an explanation of behaviour of
the aggregate of all social groups. If consistent
aggregation, in the sense of mathematically valid
aggregation of known behaviour at the micro level,
is not possible, the issue is the choice of the
appropriate level of aggregation. The following
factors influence the choice of the level of
aggregation in economic modelling: the purpose of
the model, the specification errors likely to be
involved, the data available, and the required
simplicity and parsimony. If the purpose is
pedagogical, aggregation becomes a simplifying
technique permitting a clearer understanding of the
nature of the forces at work. If the purpose is policy
formulation, for example the appropriate structure
of the tax system to promote greenhouse gas
abatement, then disaggregation of policy
instruments is essential and disaggregation of the
revenue base into its major components is advisable.
If the purpose is forecasting, then the decisions that
rely on the forecast will determine the minimum
level of disaggregation required. Aggregate macro
variables such as GDP are sufficient for the overall
management of the economy if the economy is close
Towards a New Economics
32
to full employment and management of the structure
of demand is required. And scenarios relating to
global warming will require much more detail of the
energy and industrial structure, and of the
implications for greenhouse gas emissions.
9.4 Policy Scenarios
Social choice regarding the future of the economy involves
social groups such as government, parliament and political
parties. But it also involves information. A real choice
requires the equal and simultaneous presentation of feasible
alternatives, and this can only be done properly by using a
quantitative, computable model of the system. In this way
changes in the levels of the policy instruments can be
simulated to explore how they might affect economic
behaviour. This exercise serves two purposes. First, it shows
the effects of the instruments on the targets, giving us some
indication of their ability to achieve a target without adversely
affecting other targets of policy. The second purpose of the
exercise is that it keeps a check on the plausibility of the model
as a means of simulating economic policy. When several
targets are achieved simultaneously, it is difficult to
disentangle the effects of the several instruments: the problem
is made easier if we have an idea of how each acts in isolation.
10. Representing the Energy-Environment-
Economy Systems in Models
10.1 The Challenge of Representing the System
The problem is how to represent the economic system for the
purpose of economic policy. If understanding social behaviour
is context-specific in space and time, then economic models
intended for economic policymaking must take account of
economic geography and history; moreover, the roles and
operating procedures, i.e. the institutions, governing social and
economic behaviour are fundamental. Any representation in
an economic model must assume the continuity of the roles
and the procedures of these institutions being modelled. The
implication is that the models should simulate the historical
development of the system and include specific policy
instruments for managing the system. This in turn implies the
construction and use of large-scale computable models, either
of the whole system or in part.
Towards a ‘New Economics
33
10.2 Criteria of Good Economic Models
It is worth listing the criteria of a good economic model for
economic policymaking.
1. consistent - - The treatment of the different parts of the
represented system should be internally consistent. It is a great
advantage to base a model on a system of accounts because
this enforces statistical conventions and accounting identities,
e.g. the relation between stocks and flows.
2. understandable - The model should be divided into
modules, and into different levels of scale, so that the
interconnections between economic variables can be readily
seen. If we are to understand the world, we must understand
the model. It should not be a ‘black box’, opaque to the
observer; instead, the relationships between the different
variables should be made quite clear, and a good model
structure should help to keep these clear. Models of complex
systems are not themselves necessarily difficult to understand.
Good models are, however, coherent. It should be possible to
turn the results of models into words to give a clear verbal
explanation of economic behaviour, thus giving insight into
that behaviour.
3. comprehensive - A good model should cover
comprehensively the relevant variables of those parts of the
economic system being modelled over space and time,
otherwise some of the essential connections will be missing,
and the understanding flawed. The detail may help to identify
those small effects that would otherwise be hidden in the
aggregate responses..
4. spatial and temporal - Any economic model should be
absolutely clear about the way it represents both location and
time; Adequate representation will acknowledge the regional
interactions and the path dependence of the economy.
5. able to recognise uncertainty - Models of the economy miss
out a crucial feature if they do not recognise the uncertainty in
the values of their parameters, the projections of their
exogenous variables and their general representation of the
economy.
6. documented and reproducible - Models should be well
documented and reproducible.
Towards a New Economics
34
7. at the appropriate scale - Models are built to a scale
appropriate to the objectives or requirements set by the model
builder in the use of the model. Good models simplify and
show the main features relevant to the understanding of the
systems.
10.3 Large-scale Energy-Environment-Economy Models
These ideas have been brought together in models at different
spatial scales, with the latest being a global model, E3MG
(Barker and Scrieciu, 2010). E3MG is an annual econometric
simulation model with 20 regional economies and substantial
sectoral detail including 42 industrial sectors. There is no
presumption that the economies are operating at some optimal
level in their allocation of resources or their growth rates.
Instead the assumption is that they are interacting over time in
a constrained complex system with various negative and
positive feedback loops such that behaviours become self-
reinforcing until they provoke a change in the institutional
rules.
These changes can be political, such as the break-up of
the Soviet Union, or due to the inherent tendency of some
social groups to exploit their economic power until the
behaviour causes a break in the system, as in the banking
crisis. The banks by 2007 had reached such levels of leverage
that very small reductions in the values of the underlying assets
were enough to bring about a collapse of the system, only
prevented by a change in the rules so that the major banks
avoided bankruptcy. The state via Finance Departments and
central banks reduced interest rates for central bank lending,
provided loans to troubled banks and took on the risks of
default. The most convincing account of the processes leading
up to the crisis is that by Minsky (1986, chapter 8). He argues
that during periods of expansion, the financial sector,
encouraged by success, gradually downplays risks and
uncertainties, and engages in financial innovation to create
new forms of money, leading to more and more financial
instability. The financial expansion feeds on itself through the
capital gains of the collateral real assets until the point is
reached at which it becomes clear that the real returns on the
underlying assets cannot support the loans. The system then
collapses with bankruptcies and defaults.
Towards a ‘New Economics
35
The generality of the approach lies in leaving the
explanations of consumption, investment and trade to be
consistent with the data without the constraints imposed by
traditional theory based on assuming representative agents
(Kirman, 1992), but assuming some coherence, e.g. demands
for products fall when their relative price rises. Accounting
balances should also be imposed, such as GDP components
adding up to GDP and global exports being equal to imports,
allowing for measurement errors and differences in valuation.
Other constraints can be imposed on stockbuilding and
supplies of labour and natural resources. However,
unemployment, balance of payments deficits and public sector
deficits can all easily persist for some countries, depending on
the tolerance of the population for unemployment and the
markets for debt. So the models are open with respect to the
markets for labour, foreign exchange and government debt,
allowing imbalances to persist, with an increasing risk of
institutional breaks as the unemployment and deficits increase.
Different assumptions on the resolution of the imbalances lead
to sets of scenarios, which can be developed to illustrate the
uncertainties in projections.
The financial and banking sector is represented in these
models as one of some 40 sectors of the economy, with annual
data on its output, employment, investment, trade and
purchases of goods and services from other sectors. The
models calculate the financial surpluses and deficits for the
main instructional groups in the economy and the aggregate
balances for the foreign sector. These deficits and surpluses
can lead to increasing imbalances in the underlying debt and
credit positions of the groups. However, there are also the
uncertainties associated with changes in valuations in the asset
markets, especially in dwellings. These are included as a
variable affecting the change in private consumers’
expenditure, along with changes in disposable incomes and
relative prices. One aspect of the 2008 banking crisis was the
slowing of investment by the financial sector in general, and
this exogenous shock can be imposed directly on the
projections.
If we consider the theoretical properties of the global
model in the long run and at a macro level, the crucial features
determining the effects of fiscal policies can be identified.
Fiscal policies affect prices, incomes and expenditures in the
model. The wage-price interaction is affected by the level of
unemployment, changes in global prices, such as the oil price,
Towards a New Economics
36
and productivity, with real wage rates rising according to
labour productivity. Employment and investment are derived
demands relating to real output by sector allowing for effects
of unit costs relative to the prices of output. Total demand and
supply come from industrial demand (the model uses input-
output tables), private and public consumption, and
investment. At a regional level, e.g. for the UK, exports are
added into demand and imports into supply of products.
The critical relationship affecting the global multiplier
is that of the consumption function, i.e. how long-run
consumption responds to changes in real disposable income.
Fiscal policy can affect real disposable income through the
price level, with carbon taxes and permit schemes affecting
prices, through transfers such as income tax, affecting income,
and through employment affecting total wages, the main
component of income in most regions. Government
expenditure directly on investment or incentives for private
investment will increase output and employment; and the extra
employment will lead to extra consumption in the Keynesian
multiplier process. At a regional level the size of the multiplier
will also be affected by the extent to which the region is open
to world trade. The more open an economy is to international
trade, the more any stimulus in domestic demand will go into
imports rather than domestic production, so the regional
multiplier will be smaller.
10.4 Features of large-scale ‘new economics’ models
The demand-led long-run growth in this approach is dependent
on Kondratiev waves of investment as a macroeconomic
phenomenon arising out of increasing returns, which leads to
technological change and diffusion. Other features of the
empirical modelling of growth, not limited to Post Keynesian
theory, include: varying returns to scale across industries
(which are derived from estimation), no assumption of full
employment, varying degrees of competition, the feature that
industries act as social groups and not as a group of individual
firms (i.e. bounded rationality is implied), and the grouping of
countries and regions based on political criteria. Since
technological change is embodied in gross investment (Scott,
1989), accumulated investment can be used as an indicator of
technological progress by industry and country. Quantitative
relationships can be found between technological progress as
measured and the growth in demands and/or the saving of
Towards a ‘New Economics
37
resources to meet these demands. These provide a basis for
representing the effects of technological progress on long-term
macroeconomic growth in large-scale models. The approach
allows for long-term unemployed resources and a simplified
form of the consumption function for long-term analysis. It
assumes adaptive expectations and a demand-side and
technological determination of long-run economic growth.
Uncertainty is treated through sets of scenarios, and fiscal
imbalances can be maintained or removed through variations
in government spending and tax or other revenues.
11. Conclusions
This chapter has set out the basis for a new approach to
understanding economic behaviour based on intrinsic as well
as monetary values and allowing for diversity instead of
assuming representative agents. The argument is that an
approach that allows for the diverse experience in different
sectors and world regions can be developed to give theoretical
and empirical relationships explaining economic variables such
as output, trade, employment and prices. Moreover,
technological change can be included so that it is affected by
investment and it in turn affects demand and hence economic
growth. Regional economic growth is path dependent and
essentially derived from global demand growth, but it is
constrained by the available resources, including capital and
labour. Economic policy is required to manage demand;
otherwise the system will be unsustainable in terms of
unemployment and/or inflation. Since money is endogenous,
inflation has to be managed by incomes policies and fiscal
policy. These features have been embodied in quantitative
economic models at different special scales, estimated
assuming that the time-series data show sufficient inertia to
allow the measurement of averaged responses at an industrial
level.
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This paper explores a Post Keynesian, "new economics" approach to climate policy, assessing the opportunities for investment in accelerated decarbonisation of the global economy to 2020 following the Great Recession of 2008-2009. The risks associated with business-as-usual growth in greenhouse gas (GHG) concentrations in the atmosphere suggest that avoiding dangerous climate change will require that the world's energy-economy system is transformed through wholesale switching to low-carbon technologies and lifestyles. Governments have agreed a target to hold the increase in temperatures above pre-industrial levels to at most 2ºC and have offered reductions by 2020 in GHG emissions or the carbon-intensity of GDP. The effects of policies proposed to achieve pathways to 2020 towards this target are assessed using E3MG, an Energy-Environment-Economy (E3) Model at the Global level. E3MG is an annual simulation econometric model, estimated for 20 world regions 1972-2006 adopting a new economics approach. Additional low-GHG investment of some 0.7% of GDP, with carbon pricing and other policies, is sufficient to achieve a pathway consistent with a medium chance of achieving the long-term target. Employment is some 1.5% above reference levels by 2020 and public finances are almost unaffected. Acknowledgements: the support of the Three Guineas Trust, one of the Sainsbury Family Trusts is gratefully acknowledged in funding this work.
... In this paper we approach the economics of climate change mitigation using the new economics outlined by Barker (2008Barker ( , 2011 and represented in E3MG, an Energy-Environment-Economy Model at the Global level (Barker et al. 2006; Barker and Scrieciu 2010). 1 A brief summary of the approach is given here. In contrast with traditional models, economic growth is demand-driven and supplyconstrained, with no assumption of the economy being in full-employment equilibrium. ...
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Full-text available
This paper explores a Post Keynesian, ‘new economics’ approach to climate policy, assessing the opportunities for investment in accelerated decarbonisation of the global economy to 2020 following the Great Recession of 2008–2009. The risks associated with business-as-usual growth in greenhouse gas (GHG) concentrations in the atmosphere suggest that avoiding dangerous climate change will require that the world’s energy-economy system is transformed through switching to low-carbon technologies and lifestyles. Governments have agreed a target to hold the increase in temperatures above pre-industrial levels to at most 2°C and have offered reductions by 2020 in GHG emissions or the carbon-intensity of GDP. The effects of policies proposed to achieve pathways to 2020 towards this target are assessed using E3MG, an Energy-Environment-Economy (E3) Model at the Global level. E3MG is an annual simulation econometric model, estimated for 20 world regions over 1972–2006 adopting a new economics approach. Additional low-GHG investment of some 0.7% of GDP, with carbon pricing and other policies, is sufficient to achieve a pathway consistent with a medium chance of achieving the long-term target. GDP is above reference levels because decarbonisation reduces world oil prices and increases investment. Employment is some 0.9% above reference levels by 2020 and public finances are almost unaffected.
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