Economics, at least as it is expected to function in the West, aims to achieve normatively three fundamental and sacrosanct principles: free markets, free trade and growth. Governments try to minimize their involvement in market activity and regulate carefully so as not to interfere in the investment decisions of firms, in the mechanism of price discovery, and to also prevent private actors from influencing prices such as through price fixing of goods and services or through insider trading in the financial markets. Trade is, likewise, directed by policy to be as free as can be feasible between countries, without barriers to flow of goods and services, capital and labor. Free markets and free trade are expected to allocate scarce resources efficiently within countries and between countries for both individual countries and for the world economy to continue to grow, with growth keeping up at least with the population growth rate assuming constant availability of natural resources and continuous technological advancement to use resources efficiently. Yet, these very principles constitute the critical failings of economics in practice.
Adam Smith, the moral philosopher and classical economist during the Enlightenment in Europe, had postulated that free markets, on net, raise social welfare because they are guided by an “invisible hand” as people work in enlightened self interest. Smith had perhaps overestimated the goodness and rationality in human nature. People work in self interest and many a time in selfishness and greed with little concern for the systemic affects of their actions. John Maynard Keynes in his critique of classical economics, in fact, far from seeing people as enlightened, had postulated that they act in “animal spirits”, quite irrationally, leading to dramatic ups and downs in the markets as has been evidenced several times in economic history. Still, however, governments around the world, with a bias for laissez-faire, hesitate to thoughtfully intervene, with their visible hand, to correct anomalous market behavior during times of both market euphoria and downturns. Importantly, countries which have unstable governments and poor institutions give rise to unstable economies and corruption where laissez-faire reigns in an unenlightened condition.
David Ricardo’s theory of comparative advantage, in contrast to Adam Smith’s absolute advantage driving international trade, under free trade, leads countries to import goods and services because they are cheaper to procure from abroad even though they can make them themselves. As a result, in the current global trading system, countries which benefited first from the massive technological change of the industrial revolution, the first movers, are specializing in innovation – their comparative advantage – and moving up the production value chain, increasingly substituting capital for labor thereby reducing the labor share of their national incomes causing rising income disparities and displacement of workers from their employment with capital moving to countries with low production costs. Rising welfare abroad is threatening to reduce welfare at home which eventually may also reduce welfare globally as technology diffuses more quickly around the world increasing the capital share of national income is most countries. Capital mobility was not considered by Ricardo when he postulated comparative advantage. The capitalists – the owners of capital – will benefit while the rest see heightened economic uncertainty and a fall in their living standards.
It is estimated that the rate of consumption of natural resources on Earth requires 1.7 times what the planet can provide. Economic growth is rapidly becoming the Achilles heel of economics because no amount of technological advancement and efficiency of consumption of natural resources can prevent their depletion especially as per capita incomes rise around the world and as population grows to almost 12 billion by the end of this century. Growth theory in economics does not take into account the natural resource constraint and assumes that technological change will continue to raise average living standards by raising productivity. The average living standards may rise but the distribution of income in the society would be lopsided. This will, therefore, turn out to be the wrong model of the economy particularly in light of the increasingly skewed income distribution favoring capital between the two factors of production: capital and labor.
Economics requires radical rethinking if humanity is to achieve balanced development of all in ecological harmony.