Why economics is political


Adam Smith

Economics is inevitably political. Back in the 18th century, when Adam Smith wrote The Wealth of Nations, economics was known as political economy. This was because thinkers like Smith considered the role of government in promoting the prosperity of the nation through specific policies such as providing public education and encouraging trade to be vital. He also conducted his analysis, as did all the so-called classical political economists as well as their chief critic in the 19th century, Karl Marx, in terms of classes: workers, capitalists and landlords. Conflicts of interest between them were seen, especially by Marx, as inevitable as capitalism developed and economies grew.

By contrast, modern economics, with its roots in neo-classical ideas, starts with the individual as its unit of analysis, and draws conclusions about the economy based on ‘microfoundations’: aggregate behaviour is held to flow from assumptions made about individual ‘representative agents’.

The writings of Keynes in the 1930s established the field of macroeconomics, which suggested at the time that the economy as a whole should be studied as such, as a whole, and that certain aspects of its behaviour could not be deduced simply from individual action. There were larger economic forces at work that could shape individual behaviour, and a need for government policy to more actively manage the economy in the interests of the majority. Microeconomics and macroeconomics became separate fields of study.

With the breakdown of the Keynesian consensus in the 1970s and rise of monetarist and new classical theories, Keynes’ insights were rejected, and macroeconomics increasingly became a branch of microeconomics, with apparently no separate insights that could not be derived from microfoundations.

During the post-war period when Keynesian ideas were part of the political consensus, governments across both the advanced and developing world intervened heavily in the economy, whether through industrial policy, forms of state planning, or controls on the financial sector. This was an understandable reaction to the chaos of the inter-war period and Great Depression, as well as the key role of the state in managing the war economy. The world economy grew faster than ever before (or since), and the post-war period until the 1970s has since become known as the ‘golden age‘.

The stagflation of the 1970s appeared to discredit such interventionist policies, but governments continued to intervene in economic life, although in a different manner. Policies that reduced the power of organised labour, deregulation and privatisation appeared to be in line with free-market ideas, but they all involved state intervention and new forms of regulation emerged for privatised utilities and the management of inflation.

More recently, governments intervened on a massive scale during the 2008 financial crisis and subsequent recession and the ideas of Keynes were (briefly) back in favour, before the turn to austerity.

Thus from the birth of classical political economy to the present day, there has been a continuity in that the state has managed and intervened in the economy. The policies have varied, as particular ideologies have come to prominence. In this sense economics has always been political, even when in thrall to the individual and the ‘free market’.

Why should this be so?

Economics remains nakedly political because all economic change creates winners and losers, or changes in the distribution of income and wealth across society. If the potential winners or losers from particular policies are conscious of how economic change might affect them and have some organising power, they can mobilise politically to support or resist the change. Even if the change raises overall national income, the distributional effects make the idea of the ‘national interest’ problematic.

Depending on the balance of political power between the winners and the losers from economic change, the state may end up intervening to compensate the latter from some of the proceeds of the former. This could happen through redistribution which if carefully managed, may reduce the potential for conflict between the affected groups.

An example of economic change promoted by policy is trade liberalisation between countries. This might benefit exporting companies leading to growth in their sales abroad, rising profits and increased employment and wages. But it may also lead to rising imports from more competitive foreign companies, causing weaker import-competing companies to lose markets, with the final possibility being that they go out of business, leading to job losses.

These potential outcomes from rising international trade flows will often impact on an economy unevenly, so that job losses may not be easily replaced in one region, even while employment rises elsewhere. Here lies the potential for distributional change with political effects. It is actually a fairly mainstream proposition in economics that free trade can create winners and losers, but with overall gains in welfare and income, the winners can compensate the losers through the state.

Trade policy is a simple example. More generally, the state inevitably finds itself intervening in the economy to reduce social conflict, maintain political stability and promote growth. Without such intervention as necessary, economic development would be difficult if not impossible over the long term. The activities of the state and the evolution of the capitalist economy are closely related, no matter how much some idealists would wish otherwise.


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