Krugman: “We don’t know”                                                                                               222

Phelps: “Structural slumps”                                                                                                224

Ormerod: “Death of economics”                                                                                        228

H&M: “Crisis of vision”                                                                                                      230

All authors                                                                                                                             232

43. Relating to Sen, Galbraith and Cox & Alm                                                                             232

Sen: “Development as freedom”                                                                                        232

Galbraith: “Created Unequal”                                                                                             235

Cox & Alm: “Myths of rich and poor”                                                                              242

44. Relating to the OECD and some of its authors                                                                     246

The OECD in general                                                                                                           246

The EITC, direct payroll tax reduction and wage cost subsidies                                  247

45. After 35 years of mass unemployment: An advice to boycott Holland                            250

Summary                                                                                                                                250

Introduction                                                                                                                          251

First considerations                                                                                                             251

The realism of my advice                                                                                                     254

George W. Bush and Iraq and the American economy                                                  254

More on Paul Krugman                                                                                                       256

The Dutch tragedy of the murder of Pim Fortuyn in 2002                                              256

On the European Enlargement                                                                                            259

Advice to vote NO on the current proposals for a European Constitution                260

A note on my own position                                                                                                261

Appendix: After 20 years of mass unemployment: Why we might wish for a parliamentary inquiry                262

46. Final conclusion                                                                                                                         263

Epilogue                                                                                                                                            264

Appendices                                                                                                                                           266

On the definition of economics                                                                                                     266

Biographical note on Montesquieu                                                                                              270

Price inflation and wage growth in Holland 1950-2002                                                              272

Income distribution in Holland 1950 and 1988                                                                            273

Program used in the analysis on exposed and sheltered sectors                                             275

A note on Hayek                                                                                                                              276

A note on Barrow’s “Impossibility”                                                                                             278

A constitutional amendment for an Economic Supreme Court                                                 279

A parallel argument on the Central Bank                                                                                     281

About the US Council of Economic Advisers                                                                            282

From the “Employment Act of 1946”                                                                                 282

Martin Feldstein on the US Council of Economic Advisers                                          283

Commenting on this                                                                                                             288

Presentation for the National Press in Washington 1993                                                          289

Clinton administration EITC plans for 2000                                                                                 293

Summaries of additional papers                                                                                                     298

A note on the New Economy (2000)                                                                                             299

On the 2005 edition of this book                                                                                                   300

Autobiographical note                                                                                                                    303

What is new in this analysis ?                                                                                                       305

Abstract                                                                                                                                            306

Literature                                                                                                                                           311

Index                                                                                                                                                  323

Book I
Introduction

1. Order of presentation

2. The general theory

Political Economy is the science of the management of the state. More in general, ‘economics’ is Greekish for ‘management theory’. [1] Marshall already explained that ‘economics’ is wider than ‘political economy’, see his “Principles of economics” (1947:43). The proper definitions are:

·         Economics ‘in a narrow sense’ puts the approach, methods and tools, of the discipline central, and looks at a variety of subjects.

·         Political Economy puts the subject, the management of the state, central.

·         Economics ‘in a broad sense’ joins the ‘narrow sense’ and Political Economy.

One way to view these distinctions is to visualize a matrix with the sciences in the rows and the subjects in the columns. The common economist may to some extent neglect the inputs of the other disciplines, but the political economist must draw on the resources of philosophy, history, law, sociology, politicology, social psychology, biology, physics and so on. [2] Political Economy is, just by definition, the study that tries to integrate all human knowledge about the management of the state. Political Economy is, in that respect, the proper continuation of ancient philosophy on that subject matter.

Confusions easily arise when these definitions are not understood. [3]

The reasons to adopt these definitions are rather mundane. The King - and the ruling elite - can derive their wealth (a) from exploitation or (b) from general productivity growth. The latter is more advantageous in the longer run. [4] Productivity can be increased in basically two ways: by technology or by management. For example, computers can add to our wealth, and we must have technology to be able to have computers. But a room full of computers does not present much value if we don’t manage their use. So technology and management are the two sides of the coin of human wealth. Though no study should neglect either side, there of course is advantage in some specialisation of those studies. The engineers take one side, the economists the other.

Psychologists and artists might object to that view, and argue that proper training in enjoyment and in particular the arts could teach people to enjoy life so much more, requiring neither additional engineering nor economics. In a sense, this viewpoint would seem to be correct. In another sense, it apparently isn’t sufficient. Human beings get used to levels of wealth, and require more wealth. It would be economics again to study why people are not happy eating bananas and watching sunsets. And dealing with issues like this, is management again.

Also, when writing this in 2000, and again 2004, there are some rumours about the ‘end of the state’ and the ‘loss of power of existing nation-states’. This clarifies that the definition of ‘Political Economy’ subsequently requires a definition of the ‘state’. I will not try to give that here. [5] For the purposes of this book it suffices to take the existing nation-states, and international governmental bodies, and we can reconsider that assumption when they all drop their constitutions.

Then: The economic process can be understood much better if economic policy making itself is included as one of the factors, and then is studied from the Public Choice perspective. The basic proposition of this book hence is that we can extend the current ‘neoclassical synthesis’ by including endogenous government in the model, so that we arrive at a truly general Political Economy.

This extension causes the subsequent proposition that it would be advisable for a democratic society to create an Economic Supreme Court as a separate power in the constitution next to ‘Trias Politica’ of the Legislative, Executive and Judicial branches.

It is useful to recall that economics does not restrict its attention to ‘income’ only, but also considers rights and duties. Coase’s theorem is a good result in an older tradition. Sen (1999)’s “Development as freedom” is a welcome refresher. Beckerman (1999) explains that when economic growth causes our grandchildren to be wealthier than us anyhow, that we should rather focus on bequeathing a good system of justice rather than try for even more growth. So, it is quite natural in Political Economy to also consider the law.

The basic argument is the following. Governments already have economic planning bureau’s - the US for example have the Council of Economic Advisers to the President. [6] Current forecasts are conditional on the assumption that the government will do as planned and promised. Such forecasts often fail, and can be forecasted to fail if one takes an independent position. Proper forecasting requires that the economic adviser not only has a scientific attitude, but also a scientific position, and is able to tell and indeed tells the public that plans or promises will fail if there is scientific reason for thinking so. Given the experience of the 20^th century, it appears that strong constitutional safeguards are required to provide for this public function. Hence an Economic Supreme Court.

Keynes (1936) already formulated a ‘general theory’ for political economy. Keynes subsumed the ‘classical’ approach as a special case. [7]

Keynes’s theory is rich in many respects and poor in other. On the poor side: Keynes’s book is not exact on many issues, and proper models like the IS-LM model were only developed by Hicks, Meade and others. Samuelson (1947) presented the first integration of both the competitive model and the utility maximising calculus, only then giving body to the notion of ‘classical’. [8] However, on the rich side: Keynes’s book was and still is a source of inspiration for new research angles. Note that Samuelson coined the phrase ‘neoclassical synthesis’ for ‘his’ conceptual integration of classical processes at the micro level and Keynesian processes at the macro level. This synthesis endures till today, as e.g. Colignatus (1990a), Blanchard (1999) and Krugman (1999) acknowledge. It is important to note, though, that Samuelson’s phrase is a bit awkward, since Keynes himself already proposed such synthesis - he namely did not abandon micro-economics. It would be wrong to associate Keynes only with the macro-economic leg of the synthesis. Thus the neoclassical synthesis is actually the Keynesian synthesis itself. But we may as well use the phrase ‘neoclassical synthesis’, if only to acknowledge the role of others. [9]

Keynes remains vitally present, not only for reasons of polical economy but also in the standard macro-economic core. A student who considers recent textbooks on economics, such as Mankiw (1992 and 1998) or Dornbusch & Fischer (1994), notes that the core of macro-economics still derives from Keynes (1936) and from the interpretation of his theory by the IS-LM model developed by Hicks (1937) and others. The ongoing discussion since 1936 can only be understood by properly including these original theoretical roots. Krugman gives a useful refresher in his “The return of depression economics” (1999). Flanning & Mahony (1998, 2000) provide a recommendable modern summary companion to The General Theory that is a testimony of its relevance. The theoretical extension with the Phillipscurve in its relation to unemployment and inflation belongs to this tradition. Also practical economic modelling, such as the models Athena and MIMIC of the Dutch Central Planning Bureau rely on that macro-economic core, see CPB (1990) and Graafland and De Mooij (1998).

There are also good reasons to remain modest about the novelty of the ‘new synthesis’ proposed in these pages. Keynes had an open eye to the policy making process and social philosophy. Similarly, Public Choice theorists like Buchanan and Tullock have not suggested that other factors like the macro-economy itself were not important - they only emphasised the importance of Public Choice. In that sense the presently proposed extension with institutional economics, information and Public Choice is no real extension.

In addition, the three pillars of the Trias Politica are not fully independent already. There are rather numerous dependencies instead. A modern nation has decentralised much power, and created hundreds of ‘independent organisations’ - so that some speak about ‘myrias politica’ instead of ‘trias politica’.

However, from the very definition of ‘political economy’ it follows that the function of analysing, theorising and forecasting the management of the state is a part of management itself, and this function indeed can be in danger of the other three branches.

A nation that will adapt its constitution to create an Economic Supreme Court will still feel that it takes a historical step. Similarly, economists would feel the change of perspective. It would be a different world, for example, if the US Council of Economic Advisers to the President would honestly state that they ‘would rather veto the Budget’ if they really would think so; and if they would become subject to criticism from the profession if they wouldn’t start behaving like this. So, speaking about a new synthesis is of major significance. And it can be shown to be crucial.

3. Methodology

One example is Keynes. As an economist, Keynes emphasised the economic content of his analysis: notably his findings on the peculiar role of money in the economy. His observation is firstly that money is both a medium of exchange and a store of value, and secondly that storage value depends upon expected value: and then his analysis on expectations takes off. In retrospect the force of Keynes’s analysis is a bit less ‘economics’ than he thought, and has more to do with the handling of time than with money per se. Samuelson (1947, 1983:117) and Grandmont (1983) showed that the analysis can be reproduced if money is entered in the utility functions. What remains is the issue of time. From a methodological point of view, Keynes’s theory is general in that it extends economic equilibrium with the notion that market non-clearing disequilibrium such as unemployment could be a state of expectational equilibrium too (a different concept of equilibrium). And money need not be the only cause, witness for example the difficulty of forecasting sales in order to set production. [10]  [11] [12]

Another example of the relevance of methodology appears to be Samuelson (1947). Samuelson emphasises his interest in a general theory (that word again) of economic theories, and clarifies that such a theory (i) should apply to various circumstances and (ii) be meaningful (as opposed to being a tautology). Samuelson clearly presents his argument as a methodological one. [13]

Originally, the draft of this book started out with methodology, but this discussion now has been moved downwards, to a place where one will better appreciate its argument and the need for it.

Book II
Trias Politica and Economic Supreme Court

4. The Trias Politica

5. The economic record of the 20^th century

3.       The Great Stagflation 1970 - the present (2005). [14]

4.       Disputable ways for decolonisation and development co-operation.

5.       The economic disaster in Russia and Eastern Europe after the Fall of the Berlin Wall.

6.       The environment.

Of this record, the wars are the focal points of attention.

Wars are disasters for the common citizen. Perhaps wars need to be fought for political reasons, but, an economist can express some doubt. In fact, Keynes wrote his General Theory with an eye to the threat of war:

“War has several causes. Dictators and others such, to whom war offers, in expectation at least, a pleasurable excitement, find it easy to work on the natural bellicosity of their peoples. But, over and above this, facilitating their task of fanning the popular flame, are the economic causes of war, namely the pressure of population and the competitive struggle for markets. It is the second factor, which probably played a predominant part in the nineteenth century, and might again, that is germane to this discussion.”

John Maynard Keynes, “The General Theory of Employment, Interest and Money”, 1936:381-382

Skidelsky even makes a strong case that it took the War for people to start listening to Keynes:

“In his biography of Keynes, Sir Roy Harrod reports a widely acclaimed speech delivered by his subject to the House of Lords in 1946, the year of his death. ‘But Keynes had been talking in this style ... for some twenty-seven years. Why had his words not been listened to .... ?’ (...) Unemployment as a problem in economic theory may have been sufficient to produce a revolution in the discipline; unemployment was not a sufficient problem to society to produce a revolution in political ideas. If it was not the prolonged experience of mass unemployment that finally broke the hold of nineteenth-century ideas, what was it ? A strong case can be made out for war. ‘Normal’ life could coexist with unemployment; it could not with modern war.”

Robert Skidelsky, “The reception of the Keynesian revolution”, in Milo Keynes, “Essays on John Maynard Keynes”, CUP 1975:89 & 102-103

Kennedy (1999) makes clear that ‘Keynesian’ elements like maintaining aggregate demand were prominent elements in even Herbert Hoover’s policies. Similarly, deliberate inflation was considered by Roosevelt e.g. to help farmers reduce their debt burden. Nevertheless, Kennedy has to write: “In the ninth year of the Great Depression and the sixth year of Roosevelt’s New Deal [i.e. 1938 /TC], with more than ten million workers still unemployed, America had still not found a formula for economic recovery.” (p362) There was contact between Roosevelt and Keynes, but with little effect - Roosevelt apparently regarded Keynes pejoratively as an academic theorist. Then:

“Deprived of adequate public or private means of revival, the economy sputtered on, not reaching the output levels of 1937 until the fateful year of 1941, when the threat of war, not enlightened New Deal policies, compelled government expenditures at levels previously unimaginable.” (p360)

The policy stagnation around 1938 is the more surprising, since Kennedy reports Roosevelt saying on a Fireside Chat at that time (April 14 1938): “History proves that dictatorships do not grow out of strong and successful governments, but out of weak and helpless ones.” (p362)

Keynes is an amazing person also on the following. Skidelsky makes another important point about Keynes’s role in the aftermath of the First World War in turning people’s attention from geopolitical power to economic growth:

“None of this is to deny that The Economic Consequences of the Peace was a very influential book. Of the dozens of accounts of the Treaty which appeared in the 1920s it is the only one which has not sunk without a trace. It captured a mood. It said with great authority, flashing advocacy and moral indignation what ‘educated’ opinion wanted said. It also had an influence at a deeper level. Wickham Steed was right: it was a revolt of economics against politics. The war had been fought in the name of the nation, state, emperor. These, Keynes argued, were false gods, from whom he sought to divert allegiance towards economic tasks. It was a message calculated to appeal to the nation of Cobden and Bright, once it had recovered of its intoxication with military victories. It helped form the outlook of a new generation. The nineteen-twenties saw a new breed of economist-politician, who talked about the gold standard and the balance of trade as fluently as pre-war politicians had talked about the Two-Power standard and the balance of power. (…) The idea that the creation of opulence was the main task of rulers was born in 1919 though it came of age only after the Second World War.” Skidelsky (1983:399). [15]

Reading this, one would tend to think that there still is a risk when politicians get involved with the economy.

The Trias Politica setting is usefully limited to the nation-state. However, if we were to limit our attention to the nation-state, could we really neglect the external conditions ? One would think not. A crucial chapter in the theory of the nation-state concerns the external relations: trade and war by tradition, and then, in our age: the risks of world population growth and of environmental disaster, i.e. risks that may spill over across the border. Wise managers would not close their eyes to external risks. Hence, though this book concentrates on the situation in the Western democracies, we also regard the non-democracies in the developing world.

Projections for the future indicate such external risks:

“The Global Crisis scenario (...) explores the risks and dangers of a neglect of, and late response to regional and global challenges (...) the world may end up in the throes of widespread distress, an eco-crisis, which can only be corrected at high cost. The policy message conveyed by this scenario is abundantly clear. Dismissing this scenario as unduly gloomy and pessimistic is in our view, absurd; such a statement would be tantamount to a complete denial of large segments of twentieth-century history.”

Centraal Planbureau, “Scanning the future”, SDU 1992:211

World population is forecasted in 1999 to rise to 9 billion around 2050, with a forecast error of 1.5 billion lower or higher. The central forecast already is a reduction from a forecast of 9.5 billion as the result of AIDS. This disease not only kills, but also reduces the quality of life for the surviving. Other diseases may well develop. Or, for AIDS itself, given the huge number of infected, a mutation could develop that can be transferred by flies or mosquitos too - that already transfer diseases. Another problem is that when policy succeeds in improving a situation, then such new room tends to be taken up for growth again. So it would be some kind of a miracle if the world would hit the ‘low’ 7.5 billion target with a healthy, well fed, educated and peaceful population.

UNDP administrator Speth correctly states:

“Fifty years after the adoption of the Universal Declaration of Human Rights, one third of the world’s people are enslaved by a poverty so complete that it denies them fundamental rights.” (UNDP 1999 internet site)

This quote usefully recalls to memory that Montesquieu’s liberty has been extended in this century with more rights, so that there is an even stronger intellectual case to test whether the system of Trias Politica serves the demands made on it.

Amartya Sen’s “Development as freedom” (1999) is along this line of reasoning.

The hypothesis of self-interest clarifies that Western nations are less interested in the development issue. Surely, if the Democratic State knew that economic policies were feasible that would make external development Pareto improving rather than wasteful, then it would deem it wise to pursue such a course. And part of the argument in this book is that such knowledge does not get the attention that it deserves. On the other hand, we should presume the lack of that attention, and the lack of sufficient knowledge. But we can still argue that the current world development situation should provide the West with some worry anyhow.

For Western democracies, current situations in the developing world might be regarded as replays of their own past, and as forecasts for their own future - if times of distress were to return again. A 1996 UN-WIDER statement was:

“Thus, man-made crises have become a serious, perhaps the most serious, threat to human security in the present world.” [16]

“Over the last ten years, the number of humanitarian crises has escalated from an average of 20-25 a year to about 65-70, while the number of people affected has risen more than proportionately. The International Red Cross estimates that the number of persons involved is increasing by about ten million a year. As a result, scores of people have been left dead, maimed, starving, displaced, homeless and hopeless. Afghanistan, Bosnia-Herzegovina, Burundi, Cambodia, Central America, Haiti, Liberia, Sierra Leone, Rwanda and Transcaucasia are the countries or regions where the most acute crises have occurred during the last two decades. In turn, Guyana, Kenya, Surinam and Zaire are nations where negative trends in the factors under analysis make many fear that social explosions may take place in the not too distant future, unless corrective measures are introduced urgently.” (idem)

E. Wayne Nafziger (1998), of UN-WIDER, reports in the Financial Times:

“Many people believe that humanitarian disasters are ethnically determined, arising from differences of language, race, tribe or national origin between disputants. These differences, it is thought, are so deeply rooted that they are not amenable to economic and political reform: violence cannot be avoided. That is too pessimistic a conclusion. Our research focuses on the contribution to humanitarian crises of two factors: national income and the role of the government. Both provide some reasons for modest optimism, or at least subjects for action. (…) An analysis of the root causes of humanitarian crises indicates that the mechanism for preventing them are primarily macro-economic.”

Then, there are Russia and Eastern Europe after the Fall of the Berlin Wall in 1989. The risks of turmoil in Russia, while nuclear weapons are abundantly about, were already evident in 1989, and indeed we have seen an attempted coup against Gorbachev and later the bombing of the Duma parliament building. Eastern Europe had the criminal actions of Milosevic. The risks with respect to Russia still exist. Both in 1989 and today in 2004 a reasonable expectation was and is that Eastern developments would and will be positive. But the crucial issue does not concern the average, but the risk. Who understands the economics of unemployment will see that Western economic policy is deficient on this point - a topic that we shall return to.

In the middle of 1999 the UNDP also published a report on Eastern Europe. The conclusion is that there is much more misery than commonly recognised, and that most misery is needless and also a result of wrong decisions by Western governments. In an interview with director Kruiderink, a key question and answer is:

Q: “According to some experts it went wrong precisely since the economic reforms did not go far enough.” A: “Nonsense. The ruin would only have been greater. No, precisely the reform of the state should have been the main target. Some people actually said that ten years ago, but they were not listened to. They were considered to be softies, since they wanted to maintain parts of the communist system. You currently see economists of the Worldbank and IMF slowly change their minds too.” [17]

What is crucial is that the methods, by which such dissenting ‘softies’ were silenced, were unscientific. Crucial policy preparations were left to the fric and fray of politics and bureaucrats, unworthy of a decent democracy.

There is Robert Barro’s research in the relationship between democracy and growth. An early report is in Barro (1996) [18] but he has been working on it since. His results suggest that it first takes a certain level of income before democracy has a chance. This reminds one of the willingness of Westerners to accept dictatorships in developing countries as long as economic welfare is increasing. Four comments can be made: The present discussion is targetted at existing democracies, and Barro’s finding then is only relevant as a warning of what could happen if the risk of, say, an eco-crisis would materialise. Secondly, Barro seems to imply that current democracies are finished, and that there is no next stage. But we can advance. Thirdly, once the concept of an Economic Supreme Court is clear, then one could imagine that a dictatorship on the way to a democracy (notably China) could first install such a Court - and the rule of law - before it moves towards elections. Finally, we should read Sen (1999a) as an answer to the Barro analysis, since it could rather be that democracy futhers development and growth.

Above uses plain human survival to judge on the economic record, it focusses on war, humantarian disasters, overpopulation, diseases, environmental deterioration. It is sobering to regard the more standard economic outcome. Table 1 reviews the unemployment in the European Union for 2003, reassembling the data after the enlargement of May 1 2004.

Table 1. Unemployment in the European Union in 2003

We can conclude this chapter as follows. The economic record of the last century is mixed, and human suffering was large. For the future: there still are serious risks. Bad economic conditions don’t necessarily result into wars. During the Great Depression the US remained a democracy and didn’t resort to fascism. Though it came close ! [21] Nevertheless, there can be situations in which certain politicians can rise to power by exploiting social, religious and racial sentiments - which sentiments actually draw on economic distress and uncertainty. Such is actually the rule, and stable democracy is rather the exception. Though the probability of such developments might be limited, in the currently affluent West, their costs would be great, and hence the risk may be sufficiently large to try to do something about it. If the system already fails now, what may happen if circumstances would turn out to be far less favourable ?

Since Western societies since the Second World War already have much experience with standard approaches to enhance economic security, and are apparently failing to a large degree, it becomes time to look for a more fundamental approach. We may look into the very process of economic policy making itself.

6. An Economic Supreme Court