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Tackling Inequality Needs a Rethink of Free Market Logic

Author(s): Andrew Sheng

Date: Jan 26, 2018

Theme(s): Finance & Macroeconomics, Sustainability

Publications: Opinions & Speeches

Distinguished Fellow Andrew Sheng on how the new US tax cuts reflect a view that inequality is an inconvenience.

The idea that human beings should be equal is very old. The fight against inequality between French citizens and the royalty drove the 18th-century intellectual Rousseau to write “Man is born free, but everywhere he is in chains,” sparking the French Revolution. In 1776, the newly independent United States of America wrote into its constitution, “we hold these truths to be self-evident, that all men are created equal,” although neither women nor slaves were considered equal. Nevertheless, by the 21st century, the view that all men are equal was taken as a truism, even though, to quote Orwell, “all animals are equal, but some are more equal than others.”

There are three “stylised facts” about global income inequality. First, the gap “between nations” has narrowed, mainly due to the rise of emerging markets. Second, the gap between the rich and poor has widened, especially in the past 30 years. Third, as the NGO Oxfam noted, the top eight billionaires own as much as the poorer half of mankind.

Thomas Piketty’s Capitalism in the 21st Century showed that inequalities in wealth distribution have deep political roots. Since the Nobel Prize in Economics was inaugurated, only two awards have gone to studies on inequality, the rest to quantitative economics, efficient resource allocation and market theory. Why has inequality not been the center of mainstream economics’ research agenda?

There are meta-economic reasons why economic theory, which began as “political economy”, switched to “pure science.” By the 1980s, economics became normative and quantitative, using mathematical models borrowed from physics which assumed away messy politics, rationalizing the world in elegant theories that focused on optimal policy solutions but ignored uncertainties such as financial crises and social inequities.

The philosopher Stephen Toulmin categorized Western modernity (the rise of modern science) into three phases. The first was from 1436, when Gutenberg created typeset printing, to around 1650 which coincided with the discovery of America, the quest for trade with China after the loss of Constantinople, and the flowering of art, philosophy, literature and modern science.

This period did not differentiate between nature and humanity until the Treaty of Westphalia confirmed each state as master of its own affairs with its own adopted religion. Modernity’s second phase saw a shift to secular science, rejecting ideas that blurred the human and nature. With the work of the astronomer Galileo and mathematician Rene Descartes, European thought sought to become “intellectually perfectionist, morally rigorous, and humanly unrelenting.” There was a move towards theory – a quest for universal solutions that were general and applicable for all time.

The great scientist Isaac Newton exemplified this period, shifting ideas dramatically from practical issues of human beings involving ethics and morality to theoretical concepts that sought to explain reality from reductionist, simplified models.

Newtonian science offered an ideal and stable, mechanical view of the natural world. This second phase of modernity rests on what Toulmin called the three pillars of “certainty, systematicity and the clean slate.” Modern economics, born from Adam Smith’s Wealth of Nations, offered a natural world that suited the rising power of the British empire.

Mainstream economists were enamoured with Newtonian ideas. They assumed that their general equilibrium models of the economy could offer optimal policy recommendations or projections, subject to laws that apply for all time, and that we can always start with a clean slate. In reality, the economy and market is not always in equilibrium, the rules of the game change through evolution and adaptation and starting with a clean slate is impossible. Human systems are trapped in legacies of history, culture, institutions and past experience.

After 1912, Newtonian physics was eclipsed by Einstein’s theories of relativity and quantum mechanics that recognised uncertainty and chaos as part of natural change. It is politics which explains why neoclassical economics never adapted to this profound change in scientific thinking.

The American era has been very comfortable with the timeless, universal model of the free market. Inconvenient problems such as inequality are market failures, which the state can take care of, ignoring the reality of political capture and vested interests. Free market economics suited the privileged elite because “everyone can get rich, we can always redistribute later.” But once the elite got rich, few paid serious attention to redistribution.

The tax cut proposals in the US prove this. All indicators are that the rich will benefit from them more than the poor. The hope is that the rich will invest and the middle class will spend, while welfare and health care for the needy are cut. Politics drives economic theory, which legitimises the status quo.

Recognising inequality is therefore not difficult. The real question is: what can we really do to reduce it?

 

The views expressed in the reports featured are the author’s own and do not necessarily reflect Asia Global Institute’s editorial policy.