230pp plus introduction
It is difficult to come to this book with an open mind. Its title suggests a breadth of ambition worthy only of someone with a middle initial, a professorship at Harvard and a Nobel prize, and yet Paul Ormerod is not a household name, even in utility-maximising households. Furthermore it is a slim airport paperback addressed to the general public not a weighty two-volume magnum opus. In short, it seems at first glance to lack the gravitas necessary to tackle such a topic. However, let us reserve judgment for the moment. This book is divided into two parts, the first examining economics today and how it has reached its position, the second offering us Ormerod's own vision of the way forward. I propose to examine both sections in turn, followed by a more general assessment.
The Present State of Economics
Ormerod begins by painting a dark picture of the world in general, and of economics in particular. Recessions, mass unemployment, currency instability and volatile economic cycles have all gone unforecasted by economists. The failure of practitioners to predict events of major importance leads him to wonder whether the subject can be of any use at all. This has not always been the case, however. Ormerod gives a potted history of the major economic theorists of the past, Smith, Ricardo, Marx and Keynes, emphasising the scope of their talents and noting their determination to root the subject in the real world. Against this, he juxtaposes the position of modern economists, whom he says have lost touch with reality and in fact 'positively extol esoteric irrelevance.' The profession has become more concerned with the elegance of their theories than their practical implications. Economic growth has been one of the central topics of the subject since François Quesnay and his ideas of agricultural surplus. Ormerod illustrates the strides made by the Classical thinkers in studying its determination and consequences. In contrast he highlights the inadequacy of modern national income accounting, with its reliance on pecuniary transactions and its inability to deal with externalities and the voluntary and black economies. He is scornful of attempts to rectify these problems: improvements 'would be purely definitional with no practical consequences.' Instead, a wholesale revision of the way economic welfare and economic growth are measured is needed. This may indeed be true, but in the meantime, while adjustments in the present national accounting figures may not raise or lower true national income, they surely do increase the usefulness of the figures and help policy-makers to determine the size of the public sector or the national debt. However, the fundamental point remains. To take an Aristotelian perspective, economics is a practical science. It examines a specific area of human practice with a view to deriving certain fundamental principles to guide this practice. The associated practice of economics is economic policy. The subject is therefore useful and worthwhile only in so far as it contributes to economic policy. If economics, as it is presently carried out, is of little use in guiding policy, as Ormerod suggests, then his point is indeed a valid one.
At the core of his argument is an attack on modern economic methodology with its emphasis on mathematics, as epitomised by general equilibrium and its theoretical underpinning. The environment of the late nineteenth century was one of great scientific advance. Things worked. The success of the mechanistic view of the world, which was the foundation for much of this advance, promoted a certain 'intellectual self-confidence.' This spirit was, naturally enough, carried over into economics, most especially the notion of equilibrium: the belief that left to their own devices, systems achieved a stable state. Using the concept of Rational Economic Man - a utility and profit maximiser in all cases - economists such as Walras and Jevons refined the principles of Adam Smith, and, through copying the methodology of the physical sciences, showed that there was a unique equilibrium point at which all markets cleared and which was Pareto efficient. According to Ormerod, this general equilibrium theory has now become economic orthodoxy. He identifies three reasons why this should be so. Firstly, its emphasis on the market rather than the state suited the ideological mindset of the Victorian era, a laissez-faire view. Secondly, its methodology fitted in with such success with that being used in the physical sciences. Finally, as an intellectual accomplishment alone, it was worthy of the highest praise. But, according to Ormerod, it is wrong. He attacks firstly the notion of Rational Economic Man, which paints too cold and calculating a picture of human behaviour for his liking. People co-operate more than this allows for, and he gives some anecdotal evidence to support this. Furthermore, they do not order preferences in a consistent manner. In short, people do not maximise utility at all places and at all times. Secondly, he attacks the production side of the model, or, more specifically, the notion of diminishing returns to scale. History shows, according to Ormerod, that companies can achieve constant and even increasing returns to scale, his main example being that of the United States at the turn of the century. Thus the major assumptions of General Equilibrium are violated. More fundamentally, Ormerod attacks the notion of the price mechanism at the centre of the exchange process used to derive the equilibrium. Uncertainty and a lack of information on the part of consumers and producers mean that prices do not adequately reflect true values. In extreme cases, markets may simply not exist, as in the case of goods to be bought and sold at some future date. Thus, were the assumptions of the theory still to hold, 'it is still not possible to prove that a set of prices will exist which will permit demand to equal supply in all markets.' General Equilibrium, therefore, does not hold. Furthermore, Ormerod contends, paraphrasing the Theory of the Second Best, that attempts to correct some of the assumptions may make matters worse, since if one market is not at equilibrium, it may not be optimal for other markets to be in equilibrium either.
Much of this is fair comment from Ormerod. It is certainly true that people do not and cannot always maximise their utility. Similarly, it is true that markets do not exist for all goods at all times. His analysis of the production side is questionable, however. Diminishing returns to scale do in most cases hold for a given level of technology. Ormerod is, one feels, especially in his use of America as an example, confusing increasing returns to scale with technological advance. This is however a comparatively minor point. More questionable is his notion of General Equilibrium as the holy grail of the New Right. Although the Right do have a belief in the workings of the free market, this is by no means predicated on the Edgeworth Box. Concepts such as the deadweight loss from monopoly and X-inefficiency would be much closer to their views on a micro level, while it is the flexibility of markets rather than their stability which reinforces this at a macro level. And, quite apart from this, one of the principal schools of thought, Keynesian economics and its offshoots, is based entirely within a partial equilibrium framework. To debunk the whole profession on the basis of the theory of General Equilibrium alone is simply unjust. If Ormerod is to win this battle, he needs to be better armed.
Towards the Future of Economics
What is Ormerod's alternative? He identifies unemployment as the major problem facing the world today and looks firstly at the history of employment policy. The relationship between inflation and unemployment was what concerned policy-makers and theorist in the past, culminating in the development and internalistation of the Phillips curve with the associated Non-Accelerating Inflation Rate of Unemployment (NAIRU). During the 1970s this theory broke down, and the consequent increase in the natural rate of unemployment could be explained by market imperfections, which had remained unchanged. Of course, Ormerod ignores the fact that the market had never before had to deal with such a glut of available labour in such a short period of time, and that such imperfections were only then going to make themselves felt. The resulting hysteresis was bound to push up the natural rate. However his conclusion that there is no link between inflation and the size of the unemployment stock is broadly true, though not for the reason he supposes.
He draws similar conclusions for the relationship between growth and employment: 'for any given pattern of economic growth on the basis of international experience over the past twenty years, the rate of unemployment is indeterminate.' Instead he plots unemployment against unemployment in the previous year across a range of countries. What he notices is that in general the unemployment rate seems to move in cycle around what he terms attractor points. Every once in a while the system receives a shock and unemployment changes quickly and drastically before settling around a new, usually higher, attractor point. Ormerod takes this as proof that economic systems are in fact chaotic and do not tend to return to equilibrium. The implicit assumption here is that external conditions before and after the shock are the same - were they not so, then indeed the notion of equilibrium would be a false one. This is not so though. Ormerod is simply measuring structural and cyclical unemployment. The attractor point can be simply said to represent the natural rate of unemployment for a given level of hysteresis. The movement around this level simply corresponds to the cyclical changes caused, albeit in a delayed manner, by the business cycle. After a shock, however, the labour markets are not flexible enough to cope and the structural level of unemployment rises due to increased hysteresis. Thus there is a new natural rate of unemployment and a new attractor point. This is easily demonstrated through looking at the large increase in the long-term unemployed as a percentage of total unemployment across Western Europe, showing the increased levels of hysteresis.
Ormerod ignores this, however, and proceeds to formulate a theory specially to fit in with his scatter plots. His model must settle into long periods of regular fluctuations and settle into a new pattern after a shock. He thus comes up with a relationship between unemployment and the level of profits in an economy. Simplified, it says that the proportion of profits invested in the economy varies according to expectations of the future. As investment increases, so does unemployment. The task is therefore, according to Ormerod, to increase profits. The implications of this, carried to its logical conclusion are economically absurd. It amounts to an encouragement of monopolies and a lifting of regulation to maximise profits across an economy. Patently this would hinder the efficient allocation of resources and thus increase rather than decrease unemployment. Ormerod, however, seems to be blinded by science and does not realise what his theory entails. That though, is the peril of trying to construct models on the basis of data alone, without any theoretical underpinning.
Conclusion
If there is one thing that comes across from this book, it is that Paul Ormerod is a man with a grudge. Factual inaccuracies (IBM and Microsoft have not, until recently, been in competition, for example) and petty point scoring do considerable damage to his chances of convincing economists of the merits of his argument. At every point he compares the economists of the present day unfavourably with the titans of the past. Modern theorists are grey, conforming and, above all, heartless, for Ormerod seems to be a closet Communitarian. Communitarianism is, of course, a noble philosophy, but in many places he uses this book as a vehicle for his own social beliefs, and tries to hijack his theories, as well as those of Smith and Ricardo, to this end. This is a pity, because, in spite of its many flaws, this book does have a contribution to make. Although the theory he ascribes to them is unsound, the notion of attractor points and his use of scatter plots are a useful tool in explaining cyclical and structural unemployment. General Equilibrium is indeed an untrue reflection of reality, and chaos theory may have something to offer in its place. But he is not creating a new Kuhnian paradigm. This obituary is premature. Reports of the death of economics have been greatly exaggerated.
Bibliography
Mulgan, R. G. (1977) Aristotle's Political Theory, Clarendon Press, Oxford
Ormerod, P. (1994) The Death of Economics, Faber and Faber, London