As a doctoral research fellow I have been working to identify where the various ideas that we call ‘economic rationalism’ come from whilst also trying to understand how these irrational ideas come to be championed by so many right wing politicians and their ill-educated, ignorant, and greedy supporters.
While most right-wingers like to present ‘economically rational’ ideas as being both financially and rationally justified; this is simply not the case. The vast majority of economists across the globe think that these ideas are not only silly but dangerously nonsensical. The people who study our economic systems know that these ideas are ‘junk economics’.
Yet still the majority of our politicians continue to pretend that cutting corporate taxes, reducing government services, removing corporate regulations, and allowing the rich to gather huge piles of money to pass onto their chinless offspring, is all in the best interests of our society.
The following extract is presented to assist readers in understanding just how duplicitous our politicians are being when they advocate on behalf of laissez-faire economic doctrines that are specifically designed to make the rich richer, the poor suffer, and let corporations rape and pillage our society and the global environment.
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The ‘freshwater school of economics’ is often referred to as the ‘Chicago school of economics.’ The term ‘freshwater’ was coined to contrast this school of economic thought, which was developed and championed mainly by a small number of economists practicing in Universities lying in the heart of the American continent, with the much larger, mainstream, ‘saltwater school of economics’, based predominately in the many coastal states of North America.
The majority of the original concepts which animated the ‘freshwater school’ of thinking are now considered to be arcane and outdated by both freshwater and saltwater economists alike. Both these schools of thought now tend to talk about the predominant ways of thinking about economics that are current in the modern era as constituting ‘a new synthesis’ or the ‘new economics’.
The ideas championed by the freshwater school are closely aligned with the political ideology of the Republican Party. These ideas have influenced the policies implemented by many recent Republican administrations. In contrast, the ideas of the saltwater school of economics are best typified as being a congress of more traditional economic concepts. So while the ideas of the freshwater school are largely confined to the right-wing, the ideas of the saltwater school are shared by a much broader range of economists and politicians and so have provided the rationale underlying many policy decisions taken by both Democratic and Republican administrations. A similar dynamic is evident in many other western world countries (including here in Australia).
The freshwater school of economics is the origin of the majority of the ideas that are generally known as ‘free market economics’. The theories that are central to this school of thinking relate to how these economists view the dynamics of the financial marketplace and its cyclical nature. In many ways the freshwater school might be described as being fundamentally anti-Keynesian. This is because many of the theories which define this school are based on refuting the work of John Maynard Keynes, thus advocating for a return to neo-classical ideas relating to the way in which economies function and how an economy should be managed by a government.
In the 1930s Keynes developed a series of economic theories that were largely based on a critique of many of the ideas that were central to the existing neoclassical forms of economic thinking. The neoclassical view of the marketplace is that the economy is a largely self-correcting system, where, following any downturn in demand that occasions an increase in unemployment, as long as workers are moderate in their wage demands, and there is an adequacy of resources available, the ‘free markets’ will eventually, spontaneously, return to an equilibrium in the short to medium term; all without any need for government intervention.
So, without the government doing anything, the unemployment rate will eventually fall again and activity in the marketplace will again pick up. The neoclassical view is, therefore, a conception of the economy as being a self-correcting artificial organism, driven by the need for the means of production to supply the basic materials that the community desires, and powered by the aspirations of the owners of capital to service those desires and therefore generate more profits. Thus the neo-classicists believed that ‘supplyside’ factors are always the dominant motivating and driving forces that are propelling a ‘self-correcting’ economy.
Another aspect of the neoclassical orthodoxy that is of particular significance for our investigations is the belief that the relationship of the individual to the economic activity within society is best conceived in a naïve manner. The neo-classicist generally conceived of society as being constituent of self-interested autonomous individuals making rational decisions that are in their own best economic interests. So rather than focussing on classes of citizens, or aggregations of economic interest, the neoclassical view is that society is best described in a manner that roughly parallels the modern neoliberal concept of society as being a community of atomised and autonomous decisionmakers.
Keynes, however, refuted the idea that the marketplace was ‘self-correcting’. He asserted that the economy had to be managed by governments in a proactive manner because the aggregate demand for products would often fall below the output capacity that the owners of capital had generated to service the requirements of the marketplace at its peak, so without constant ongoing government intervention, the economy would always be subject to a boom and bust cycle. Moreover, due to the slow development of efficiencies in the means of production, and the concentration of capital resources within particular segments of the economy (and other factors), without government intervention the economy would often breed high levels of unemployment even when there was both a sufficiency of demand for products and relatively stable and moderate wage outcomes. So governments had to manage the economy by utilising fiscal policies. In other words, governments had to always manage the amount of money that was available in the economy, the relative value of the currency, the minimum wages being paid to workers, the conditions of employment, interest rates, and other significant factors that impact upon the economic environment. So Keynes was in favour of interventionist fiscal policies. By the mid-1950s virtually all western world governments had adopted most of Keynes policy prescriptions for running an economy.
The majority of the ‘saltwater school of economics’ might be described as being those economists who are modern Keynesians, although prior to the 1970’s there was no real need for such a distinction because the mainstream of economics was almost exclusively focussed on elaborating Keynesian ideas, with the various schools of economic thought all generally being in favour of interventionist governments applying different mixes of fiscal policy prescription. Economics was mainly all about squabbles regarding the nature of the best types of interventionist policy prescription rather than whether or not they were required at all.
Then along came the 1970s and America suffered a period of economic downturn caused by what is known as ‘stagflation,’ which is an economic condition where there is a long period of high inflation, high unemployment, and stagnant demand. In response to these conditions the interventionist fiscal prescriptions proposed by the various mainstream schools of economic thinking did not seem to be able to provide any adequate nor ready solutions.
From the end of WWII until the 1970s both the conservative and the more liberal elements of the political culture in the US were largely united in believing that the employment of one or another form of Keynesian fiscal policy was the best way to run a complex modern economy. However, during the downturn of the 1970s, the conservative forces in American politics were also becoming far more radical than they had been for the previous two and a half decades. During this period, bipartisan agreement regarding the Keynesian solution broke down, and many of the more radical conservative politicians began to advocate on behalf of a return to a more neoclassical approach where the government stepped back from the economy and let it ‘run itself’. This breakdown in economic bipartisanship was primarily driven by ideological aspirations favouring ‘small government’ and a consequent adoption of a more laissez-faire approach to corporate and social regulation and government spending.
So, in the 1970s, the more conservative forces in American politics began championing the ideas of Milton Friedman, of the University of Chicago, and other theorists who were generating economic theories that accorded with their own ideological prescriptions for society. This led to the rise of the freshwater school of economics. This brief history assists in explaining why this small group of economists, proposing theories that were well outside of the mainstream of economic thinking, came to be so influential.
In 2008 the economist Paul Krugman described the freshwater school in the following manner:
‘… macroeconomics has divided into two great factions: “saltwater” economists (mainly in coastal U.S. universities), who have a more or less Keynesian vision of what recessions are all about; and “freshwater” economists (mainly at inland schools), who consider that vision nonsense.’
‘Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work…’
‘The neoclassical revival was initially led by Milton Friedman of the University of Chicago…’
‘Friedman’s counterattack against Keynes began with the doctrine known as monetarism. Monetarists didn’t disagree in principle with the idea that a market economy needs deliberate stabilization. … Monetarists asserted, however, that a very limited, circumscribed form of government intervention namely, instructing central banks to keep the nation’s money supply, the sum of cash in circulation and bank deposits, growing on a steady path – is all that’s required to prevent depressions. … Friedman made a compelling case against any deliberate effort by government to push unemployment below its “natural” level (currently thought to be about 4.8 per cent in the United States): excessively expansionary policies, he predicted, would lead to a combination of inflation and high unemployment – a prediction that was borne out by the stagflation of the 1970s, which greatly advanced the credibility of the anti-Keynesian movement.’
‘Eventually, however, the anti-Keynesian counterrevolution went far beyond Friedman’s position, which came to seem relatively moderate compared with what his successors were saying’.
In simple terms, the freshwater school of economics extrapolated upon the relatively temperate theorising initially engaged in by Friedman regarding the need to return to neoclassical principles, until eventually, it came to be advocating for governments to not manage the economy at all. Their policy prescriptions were all about reducing (or preferably abolishing) most forms of government spending (but not military spending), privatising any parts of the government that unfortunately still had to spend money, reducing corporate and personal taxes, removing as many other taxes as possible, and doing away with any regulations that might impact upon corporate practices. At the core of this school of thought was the idea that our society is primarily an economy, and since economies are self-correcting, governments should simply ‘get out of the way’ and let economic forces run their course.
The administration of Ronald Reagan, which spanned virtually the entire decade of the 1980s, embraced many of the concepts being advocated by the freshwater school of economics. At the same time these ideas spread to many other western world countries. Ideas which are now commonplace within the majority of western world democracies, such as ‘trickle-down’ economics, ‘economic austerity,’ boosting the economy by cutting corporate taxes, reducing income tax levels and government spending, eliminating peripheral taxes, reducing government ‘red-tape,’ and most other ‘free market’ ideas, all spring from the embrace by the Reagan administration, and right wing politicians across the globe, of ideas that were initially advocated by the freshwater school of economics.
However, even before the turn of the last century, many western world governments were already returning to a more Keynesian approach to governing their economy. This is because, while the benefits of laissez-faire policies were largely debatable, the growing inequality and wages gap occasioned by the employment of these policy prescriptions was not. Nor were the constant high levels of unemployment, increasing government indebtedness, the harmful effects of degraded government services, the negative social and environmental impact of reductions in corporate regulation, the growing instability in financial markets, the appearance of housing bubbles, and the consequent social unrest.
It must be stressed that even while the freshwater school of economics was immensely influential politically, it had always represented the thinking of just a small fraction of the professional and academic economists across the western world. The majority of these economists have always regarded the theories being put forward by this group of academics as being invalid at best, and dangerously nonsensical at worst. However, because these ideas aligned so well with the ideology of many right wing politicians across the western world, they had a grossly disproportionate impact upon the nature of the policy prescriptions being implemented across the globe. Or at least they did until the global financial crisis of 2008/9.
The reason that the majority of economists have always considered this school of theoretical endeavour to be dangerous and silly, and why the global economic crisis marked the point beyond which not even the most rabidly committed of academic economists could any longer advocate on behalf of these theories, is best left to an economist to explain, so once again we turn to Paul Krugman:
‘Freshwater economists are, essentially, neoclassical purists. They believe that all worthwhile economic analysis starts from the premise that people are rational and markets work…’
‘As they see it, a general lack of sufficient demand isn’t possible, because prices always move to match supply with demand….’
‘But don’t recessions look like periods in which there just isn’t enough demand to employ everyone willing to work? Appearances can be deceiving, say the freshwater theorists. Sound economics, in their view, says that overall failures of demand can’t happen – and that means that they don’t. Keynesian economics has been “proved false,” Cochrane, of the University of Chicago, says.’
‘Yet recessions do happen. Why? In the 1970s the leading freshwater macroeconomist, the Nobel laureate Robert Lucas, argued that recessions were caused by temporary confusion: workers and companies had trouble distinguishing overall changes in the level of prices because of inflation or deflation from changes in their own particular business situation. And Lucas warned that any attempt to fight the business cycle would be counterproductive: activist policies, he argued, would just add to the confusion….’
‘Put baldly like that, this theory sounds foolish – was the Great Depression really the Great Vacation? And to be honest, I think it really is silly’.
So, due to the extended ‘temporary confusion’ and widespread ‘vacations’ that were occasioned by the global financial crisis, the freshwater school of economics was finally discredited so absolutely that these ideas have largely been abandoned by even the most committed of former advocates. Even the economists who are still members of the Chicago School of economics have now modified their ideas. To once again quote Paul Krugman, the economists at Chicago University have, in recent times, become ‘more brackish every year’.
Yet, of course, this has still not dissuaded many right wing politicians from continuing to advocate on behalf of laissez-faire economic theories. Presumably on the basis that, while their policy prescriptions remain valid and accurate; reality continues to get it wrong.
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