Monthly articles (English and French) on the theme "Querying economic orthodoxy"

No. 33 - September 2008

Economics should promote economy


Climate is an angry beast and we are poking at it with sticks.
Wallace S. Broeker, professor of geology at Columbia University (New York), Lamont-Doherty Earth Observatory

One of the hardest lessons that climate change teaches is that the economic model of growth and the frenetic consumption of the rich nations are ecologically unsustainable.
Human Development Report 2007/08 (United Nations Development Programme)

Current economic policies, based on nineteenth-century theory, deliberately promote maximum production and consumption of most goods. In today's world, where natural resources of all kinds are under pressure, such policies are no longer tolerable.

The curse of oil-dependance

In the troubled world of energy, Russia and Iran rank among the major producers of crude oil and natural gas. And these vital commodities are at present extremely lucrative. The producing countries are earning enormous revenues from their hydrocarbons, and some of them are clearly using their new-found riches to throw their weight about. We have to live at peace with these difficult neighbours, but we have no wish to be bullied and pushed around by them. Does this problem have a workable solution?

Yes! there is, indeed, at least a partial solution; very simple in principle, though more difficult to apply in practice. We simply have to burn less oil and gas. A significant cut in consumption would lead to much lower prices. The cost of 'lifting' oil and gas from existing wells is on average (1) only about $6 per barrel; the startup or 'finding' costs of exploration and development (for new wells) vary (2) from just over $5 per barrel in the Middle East to $64 in US offshore areas. So, even at prices far below today's, oil and gas could still be supplied profitably; but the producing countries would become less rich, therefore less powerful and arrogant. With lower consumption levels, supplies would be less stretched; consuming countries could more easily switch from one source of oil or gas to another; it would be harder for any producing country to impose its wishes with the threat of cutting off supplies.

In fact, a cutback in consumption would still be necessary, even if we had no problems with the producing countries. We need urgently to reduce our combustion of fossil fuels if we are to avoid further polluting our atmosphere, deranging our climate, and exhausting our reserves. Remember that petroleum and its relatives (gas, coal, tar etc.) are needed for other purposes than simply burning them to generate energy. They are essential feedstocks for many industries, among others pharmaceuticals, chemicals, plastics and textiles.

The wider resource problem

On a broader view, we (the human race as a whole) are consuming many of our raw materials at unsustainable rates, and the problem is getting worse as developing countries emerge from their traditional poverty to adopt modern lifestyles. Rich countries need to consume less wastefully; developing countries need to try to grow without acquiring the extravagant habits of today's West. As Emil Salim, a former minister in the Indonesian government, has aptly remarked (3), the twentieth century is a bad model of development.

The theory of maximum consumption

One reason that our present model is bad is that most Western countries today follow a basic economic theory that, quite deliberately, encourages maximum consumption. Back in 1871, the Viennese economist Carl Menger explained how competition has the effect of maximising sales volume, and thus consumption. He objected, as do most economists today, to anti-competitive behaviour, which he called monopoly. He did not necessarily mean a situation where there is only one supplier of any given product. Monopoly, in his sense, can also mean the case where there are several or many suppliers, who agree among themselves to co-ordinate their sales volumes and prices.

You may not have heard of Menger, professor of economics in Vienna between 1879 and 1903, who was also tutor to Rudolph von Hapsburg, the hapless crown prince who died with his mistress at Mayerling in 1889. Menger is not well known today, except to economists; but he has an important place in history as the founder of what we call the Austrian School of economic theory. This is essentially a more sophisticated and uncompromising version of the laisser-faire philosophy that we can trace back to Adam Smith.

Those Viennese economists of the late nineteenth century lit a very long fuse. Their ideas were generally neglected until around 1970, when they exploded into sudden prominence and gained wide acceptance around the world. Today, the writings of Ludwig von Mises, a follower of Menger, are famous and influential in America, while Friedrich von Hayek, a pupil of Mises, was Margaret Thatcher's favourite guru. So the thoughts of Professor Menger, whether we like them or not, are still very much with us.

What, then, did he have to say about monopoly and competition? He explained (4) how monopoly usually causes only part of the quantity of goods at the command of the monopolist to be offered for sale, or only a part of the available means of production to be put to use. He continues: true competition always puts this malpractice to an end immediately…and usually has the further effect of increasing the available quantity of a previously monopolized commodity.

A fishy example

To see how this works, we may consider the simple case of the fish market in Aberdeen, where many years ago my grandfather James Owen Angus had a prosperous haddock-smoking business. The auctioneer (generally called the salesman), facing a crowd of fish merchants, has to sell - shall we say - five hundred boxes of haddock. His job is to sell all the boxes at best possible prices. On a good day, if the haddock are mostly large, he might realise an average price of around £100 per box of 50 kilos.

Now, suppose that the fishermen who land haddock at Aberdeen had an association through which they could all agree to strictly co-ordinate their catching and selling strategy. I hasten to add that the practicalities of fishing make this difficult; but such an agreement is, at least, theoretically possible. This association would act as Menger's hated monopolist. Its members might find that by deliberately limiting their catches so as to offer the market only 450 boxes, they could get an average price of £120 per box; total revenue £54,000 rather than £50,000. Good business for them, and good for the conservation of fish stocks.

But in reality, fishermen do not generally behave like this. There may be a certain amount of informal collusion, but as a rule they act more or less independently (competitively). They do not indulge in the practice, loathed by economists, of running an effective cartel. So, if any one fisherman wanted to get the price up from £100 to £120 a box, he could not be confident that the others would help him by reducing their own catches. His only sure way of raising the price would be to cut back his own catch to the full extent necessary. But that would mean delivering 50 fewer boxes to the market. Even if this fisherman has the biggest boat in the fleet and lands 20% of the haddock catch (100 boxes), he would have to halve his own catch. He clearly could not gain by doing that. His revenue would fall from £10,000 to £6,000.

So, in normal competitive conditions, no fisherman can improve his income by independently deciding to catch fewer fish. To maximize his income, each has to catch and sell as many as he can (5). Thus, says Menger (6), one of the socially most injurious outgrowths of monopoly (für die Gesellschaft verderblichste Auswüchse des Monopolhandels) is removed by competition. His chosen term, verderblich, is an unpleasant adjective whose meanings include pernicious, corrupt, perverse, vicious. It describes perfectly what free-market economists think of any attempt to restrain competition.

Should we maximise consumption?

We see, then, that the fully competitive market, with no shameful collaboration between producers or sellers, is a machine that encourages maximum sales, thus as much production and consumption as possible, at keenest possible prices. Economists from Adam Smith to Milton Friedman have generally regarded this as socially desirable. More sales of everything mean greater consumer welfare, as economists put it.

This attitude was understandable in the nineteenth century when the European population was made up largely of very low-paid working people, who lived at a pretty basic level. It was agreed that raising their standard of living was a praiseworthy objective. Moreover, in those days there were few concerns about exhaustion of natural resources. In 1870, when Menger was completing the book from which I quote, world population was around 1.3 billion, a mere fifth of its present level; and the great majority of people lived, by today's standards, frugally.

The curse of waste

Today, standards of living are higher and almost all of us, in one way or another, live wastefully, though not always from choice. Most of us are pestered with unwanted junk mail, which consumes a lot of paper. Many of us go daily to work by car, whereas a century ago one walked or took a train or tram; today, in many places, convenient public transport is not available. Modern distribution methods for foodstuffs and other goods use huge quantities of packaging, mostly of plastic and thus derived from oil. These familiar and tiresome facts reflect an economic system governed with the deliberate aim of maximising production and consumption of physical objects.

Traditional systems, under which guilds and governments regulated production without necessarily aiming to maximise it, have been continuously ridiculed and vilified for well over two hundred years; by Adam Smith and his followers in the eighteenth century, by Menger and his followers in the nineteenth, by Mises and Hayek and many others in the twentieth. We have allowed ourselves to be brainwashed into believing that the fully-competitive market is the only right way. The French journalist Nicolas Weill recently described this very well; he wrote (7) of a free-market ideology which claims, in a manner strangely close to that of yesterday's Stalinist gospel, to be in tune with the very nature of things and to exclude any possible alternative.

We cling to the belief that we must have untrammelled competition in every kind of economic activity; we hunt down and shame and punish those who offend against this rule. But this means that our economic system continues to drive consumption of everything upwards. Can it make sense in a world where overconsumption of resources threatens to lead to disaster?

A change of incentives

Instead, we need to find ways of managing the economy so that our incentives do not push us to maximise the production and consumption of everything. Restraints on price competition could divert the competitive spirit towards selling on quality and long life, rather than on low price. Manufacturers would have an incentive to make things durable, and repairable, rather than cheap and ephemeral - thus using smaller quantities of materials over the long term.

This habit used to be quite normal; the economy of cheap throwaway goods is comparatively new. I have a fine gold pocket-watch (a hunter) inherited from my grandfather, the fish-curer, and an equally fine silver propelling pencil which belonged to a great-uncle. These beautiful things, around a hundred years old, are still in perfect working order, and it is a pleasure to use them. Who says you cannot live well without squandering resources?

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1 See US Govt. Official Energy Statistics, performance profiles, table 10

2 Ditto, table 11

3 Emil Salim, former minister for the environment in the Indonesian government, see Le Monde, 13 February 2007.

4 Carl Menger, Principles of Economics (Grundsätze der Volkswirtschaftslehre, Wien, 1871), trans. J Dingwall and B F Hoselitz (New York University Press, 1976), chap. 5

5 In the fishing industry today, production is indeed generally limited by governments, which impose restrictive quotas to prevent over-fishing and the exhaustion of stocks. But it was not so in my grandfather's day. In our own times, other consumer goods industries by and large escape such restraint.

6 Menger, loc. cit. supra

7 Nicolas Weill, Le Monde, 30 July 2008