See the Big Picture

This post is part of a reading series of Doughnut Economics, by Kate Raworth. Being the result of a personal work, it cannot and does not pretend to express each and every point exposed by the author, let alone to do it in a totally adequate and exact manner. I can only encourage, for that matter, to read the book itself.

Let the rest of us know what you think! As in any book club, the purpose is to help you share your views. You are, therefore, kindly invited to answer the question(s) asked at the end of what you are going to read.

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Ch. 2: SEE THE BIG PICTURE — From self-contained market to embedded economy

By heavily scripting the economic narrative since the late 1940s, market fundamentalists have proven William Shakespeare right. What should the economy’s cast look like in the 21st century?

“This chapter reveals the cast of characters, the script, and the playwrights behind the economic story that came to dominate the twentieth century—the one that has pushed us to the brink of collapse. But it also sets the stage for a twenty-first-century economic play—one whose characters and script can help bring us back and into a thriving balance.” (Raworth, Kate. Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist (p. 54). Chelsea Green Publishing.)

Setting the Stage

The plot has its key characters “tacitly named through the most iconic diagram in macroeconomics, the Circular Flow.” (Id. p. 54) This diagram was given to the world by Paul Samuelson in Economics, a college manual published in 1948 (the latest edition is from November 2010). Originally devised to simply illustrate how money flows in the economy, the Circular Flow soon came to define the economy itself, thus “determining which economic actors were placed centre stage and which were shunted to the wings.” (Id. p. 54) Incidentally, this diagram happened to perfectly fit with the reductionist view of economics held by the neoliberal school of economics that had just been born when Paul Samuelson published his book.

The play broadly unfolds this way: “Centre stage is the market relationship between households and business. Households supply their labour and capital in return for wages and profits, and then spend that income buying goods and services from firms. It is this interdependence of production and consumption that creates income’s circular flow.” (Id. p. 55) As a whole, consequently, the Circular Flow system is closed and complete. To its inventor’s credit, it has proved to be a useful base for figuring out different ways of measuring national income and for making visible various macroeconomic ideas. But this diagram’s limit is precisely that it only illustrates the flow of income, thus leaving out of the picture key elements embedded in the real economy—such as the energy and materials on which economic activity depends, or the society within which those activities take place.

Economics: The Twentieth-Century Neoliberal Story

As per what would become the dominant economic story over the world, nevertheless, the cast of the play has its different roles distributed as follows:

Market: “When the market’s invisible hand is set free to work its magic of allocative efficiency, it harnesses the self-interest of households and business to provide all the goods and jobs that are wanted.” (Id. p. 59)

Business: “Firms bring together labour and capital to produce novel goods and services and to maximise their profits. There is no need to look at what goes on in their factories and farms, so long as they play within the legal rules of the game.” (Id. p. 59)

Finance: “Banks take people’s savings and dutifully turn them into profitable investments. Furthermore, according to Eugene Fama’s influential ‘efficient-market hypothesis’ of 1970, the price of financial assets always fully reflects all relevant information.1 Hence, financial markets are ever adjusting but always ‘right’—and their smooth operation should not be distorted by regulation.” (Id. p. 59)

Trade: “David Ricardo’s nineteenth-century theory of comparative advantage demonstrates that countries should focus on what they are relatively good at doing and then trade: both parties will gain from it, no matter how unequal they are.” (Id. p. 60)

State: “Beyond defending the nation’s borders and its citizens’ private property, it is quite simply best for the state to leave it to the market.” (Id. p. 60)

Other main characters such as Household, Commons, Society, Earth, and Power are not required on the stage in Neoclassical economics. In reality, however, these characters have always played a role. Not allowing them to do so in economic theory has led the world to the income inequality and environmental dead-end it is in now.

A New Century, a New Show

It consequently appears that rather than how to get income flowing around the economy, the more fundamental question is: what do we depend upon to provide for our needs? A new set of characters has to take the stage. Best, here again, is to let Kate Raworth speak in her own words.

Earth: “The economy depends upon Earth as a source—extracting finite resources such as oil, clay, cobalt and copper, and harvesting renewable ones such as timber, crops, fish and fresh water. The economy likewise depends upon Earth as a sink for its wastes—such as greenhouse gas emissions, fertiliser run-off and throwaway plastics. Earth itself, however, is a closed system because almost no matter leaves or arrives on this planet: energy from the sun may flow through it, but materials can only cycle within it.” (Id. p. 64)

Society: “Community connectedness is not just about warm fuzzy tales of civic triumph,’ writes Putnam; ‘In measurable and well-documented ways… social capital makes us smarter, healthier, safer, richer and better able to govern a just and stable democracy.”, says the political theorist Robert Putnam.2

Economy: “(…) while the Circular Flow diagram identified people primarily as workers, consumers and capital owners, the Embedded Economy diagram invites us to acknowledge our many other social and economic identities. In the household, we may be parents, carers and neighbours. In relation to the state, we are members of the public, using public services and paying taxes in return. In the commons, we are collaborative creators and stewards of shared wealth. In society, we are citizens, voters, activists and volunteers.” (Id. p. 67-68)

Metz, Conrad Martin, 1749-1827; Margaret Douglas, Adam Smith's Mother
Margaret Douglas (1694 – 1784), Adam Smith’s Mother.

Household: “The Circular Flow diagram depicted labour appearing—hey presto!—fresh and ready for work each day at the office or factory door. So who cooked, cleaned up, and cleared away to make that possible? When Adam Smith, extolling the power of the market, noted that ‘it is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner’, he forgot to mention the benevolence of his mother, Margaret Douglas, who had raised her boy alone from birth. (…) a 2014 survey of 15,000 mothers in the United States calculated that, if women were paid the going hourly rate for each of their roles—switching between housekeeper and daycare teacher to van driver and cleaner—then stay-at-home mums would earn around $120,000 each year. Even mothers who do head out to work each day would earn an extra $70,000 on top of their actual wages, given all the unpaid care they also provide at home.”3

Market: “Adam Smith’s great insight was to show that the marketplace can mobilise diffuse information about people’s wants and the cost of meeting them, thereby coordinating billions of buyers and sellers through a global system of prices—all without the need for a centralised grand plan. This distributed efficiency of the market is indeed extraordinary, and attempting to run an economy without it typically leads to short supplies and long queues.” (Id. p. 70)

”There is, however, a flip side to the market’s power: it only values what is priced and only delivers to those who can pay. Like fire, it is extremely efficient at what it does, but dangerous if it gets out of control. When the market is unconstrained, it degrades the living world by over-stressing Earth’s sources and sinks. It also fails to deliver essential public goods—from education and vaccines to roads and railways—on which its own success deeply depends.” (Id.)

”That is why the market’s power must be wisely embedded within public regulations, and within the wider economy, in order to define and delimit its terrain. (…) And, strange though it sounds, that means there is no such thing as deregulation, only reregulation that embeds the market in a different set of political, legal and cultural rules, simply shifting who bears the risks and costs and who reaps the gains of change.” (Id. p. 70-71)

Commons: “The commons are shareable resources of nature or society that people choose to use and govern through self-organising, instead of relying on the state or market for doing so. Think of how a village community might manage its only freshwater well and its nearby forest, or how Internet users worldwide collaboratively curate Wikipedia.“

Elinor Claire “Lin” Ostrom (1933 – 2012)

“In the 1970s, the little-known political scientist Elinor Ostrom started seeking out real-life examples of well-managed natural commons to find out what made them work—and she went on to win a Nobel-Memorial prize for what she discovered. Rather than being left as ‘open access’, those successful commons were governed by clearly defined communities with collectively agreed rules and punitive sanctions for those who broke them.4 Far from tragic, she realised, the commons can turn out to be a triumph, outperforming both state and market in sustainably stewarding and equitably harvesting Earth’s resources (…)” (Id. p. 71)

State: “Put it this way: in the film of the play, the state should be aiming all-out to win Best Supporting Actor at the Oscars—starring as the economic partner that supports the household, the commons and the market alike. First, by providing public goods—ranging from public education and healthcare to roads and street lighting—that deliver for all, not just for those who can pay, so enabling a society and its economy to thrive. Second, by supporting the core caring role of the household, such as with maternal and paternal leave policies that empower both parents, investment in early-years education and care support for seniors. Third, by unleashing the dynamism of the commons, with laws and institutions that enable their collaborative potential and protect them from encroachment. Fourth, by harnessing the power of the market by embedding it in institutions and regulations that promote the common good—from banning toxic pollutants and insider trading to protecting biodiversity and workers’ rights.” (Id. p. 73)

“Like all best supporting actors, the state may also step centre stage, taking entrepreneurial risks where the market and commons can’t or won’t reach. The extraordinary success of tech companies such as Apple is sometimes held up as evidence of the market’s dynamism. But Mariana Mazzucato, an expert in the economics of government-led innovation, points out that the basic research behind every innovation that makes a smart phone ‘smart’—GPS, microchips, touchscreens and the Internet itself—was funded by the US government. The state, not the market, turns out to have been the innovating, risk-taking partner, not ‘crowding out’ but ‘dynamising in’ private enterprise—and this trend holds across other high-tech industries too, such as pharmaceuticals and biotech.”5 (Id.)

Finance: “Three long-held myths make up the traditional story of finance: that commercial banks work by turning people’s savings into investments; that financial trading smoothes out the economy’s fluctuations; and that, therefore, the financial sector provides a valuable service to the productive economy. All three of these myths were busted very publicly by the 2008 financial crisis. Far from simply lending out savings, banks magically create money as credit. Far from promoting stability, financial markets inherently generate flux. And far from providing a valuable service to the productive economy, finance has turned into the tail that wags the dog.” (Id. p. 74)

Business: “Operating within the realm of the market, business can be extraordinarily effective in combining people, technology, energy, materials and finance to create something new.” (Id. p. 75) Power, however, “is always at play between a firm’s waged workers and its shareholding owners because of the vast inequalities between them (…) Ensuring workers’ rights to organise and bargain collectively is one way of offsetting such deep power imbalances; another is to change the ownership structure of the firm itself, ending the centuries-old divide between workers and owners (…) What’s more, Friedman’s narrow view on the business of business has lost credibility: in the face of twenty-first-century challenges, firms need a purpose far more inspiring than merely maximising shareholder value (…)” (Id. p. 75-76)

Trade: “Ricardo’s influential theory of win–win trade was based on products such as wine and cloth, and assumed that the factors of production—land, labour and capital—were immovable behind national borders. Today, everything but land moves, with cross-border flows including trade in products and services (from fresh fruit to legal advice); foreign direct investment (in businesses and properties); financial flows (from bank loans to corporate stocks); and the migration of people in search of a livelihood.“ (Id. p. 76)

David Ricardo (1772 – 1823)

“Ricardo was right in thinking that very different nations may be able to trade to mutual gain, but comparative advantage is not only what you are blessed with: it is something you can build. As Ha-Joon Chang puts it, however, today’s high-income countries are ‘kicking away the ladder’ that they once climbed, recommending that low- and middle-income countries open their borders to follow a trade strategy that they strategically avoided themselves.”6 (Id. p. 77)

Power: “Out of all of these power relationships, when it comes to the workings of the economy, one in particular demands attention: the power of the wealthy to reshape the economy’s rules in their favour. Samuelson’s Circular Flow diagram inadvertently helped to gloss over this matter by depicting households as a homogeneous group, each one offering its labour and capital in return for wages and a share of profits—which are, in turn, paid out by a cluster of homogeneous firms.” (Id. p. 77-78)

In order to reshape the economy’s rules in their favor, wealthy individuals and large corporations have no better leverage than a system of legalized bribery: “In politics, money talks—when it must in public, but preferably in private, with hidden handshakes, closed-door meetings and under-the-table kickbacks. These relationships obey a powerful ‘golden rule’, says the political scientist Thomas Ferguson, based on his long analysis of US political funding. Business effectively invests in political candidates and expects a return on that investment in the form of favourable policies. ‘To discover who rules, follow the gold,’ he advises: trace the finance backing any major political campaign, and you’ll see what drives its policies.” 7

Your turn! How would you sum up the difference between a “self-contained market” and an “embedded economy”, as described by Kate Raworth? Would you add anything to her description? Share your thoughts in the comment section below.

PS: While you are at it, please consider sharing this post too. 🙂

Footnotes

  1. Eugene F. Fama: Efficient Capital Markets: A Review of Theory and Empirical Work
  2. Putnam, R. (2000) Bowling Alone, p. 290.
  3. Salary.com (2014), 2014 Mother’s Day Infographics
  4. Ostrom, E. (1999) Coping with tragedies of the commons, Annual Review of Political Science 2, pp. 493–535.
  5. Mazzucato, M. (2013) The Entrepreneurial State. London: Anthem Press.
  6. Chang, H-J. (2010) 23 Things They Don’t Tell You About Capitalism, London: Allen Lane
  7. Ferguson, T. (1995) Golden Rule: the investment theory of party competition and the logic of money-driven political systems. London: University of Chicago Press, p. 8.
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