Last week, a book of mine was published – in German for now – in which my kind of economics (what I call relevant economics) is given a scientific basis. The title is: “Principles of Relevant Economics”. Eight most important statements (representing the 8 chapters of the book) are printed on the back of the book, which I would like to explain in more detail below for my English-speaking readers.
The Great Depression is still not understood after a hundred years
There are numerous attempts to explain the most far-reaching economic event of the past hundred years, but they are completely inadequate. An unsuitable theory stood and still stands in the way of the majority of economists. We have put a great deal of effort into collating wage data from various countries for the global economic crisis at the beginning of the 1930s. They provide the empirical basis for a sound explanation that combines logic and evidence. This offers the opportunity to learn from history and avoid repeating the serious mistakes of that time.
As in 2008/2009, the rise in unemployment was caused by the bursting of a financial bubble. It can be proven that it led to a reduction in wages in the industrialised world – in the order of 20 to 30 percent. Apparently, trade unions, employers and the state agreed that this was an appropriate response to stabilise economic development. The exact opposite is true.
In addition, the chapter provides a detailed history of economic and economic policy development over the last 75 years with empirical evidence that is new in this form. It shows that it was only during the Bretton Woods monetary system that optimal conditions for investment activity prevailed
Schumpeter is more important than Keynes
I did not set out to provide a comprehensive review of the economic literature in this book, but on reflection I felt it was important to outline what I see as the key advances in economic thinking to date. There has only been one serious attempt in the past 200 years to overcome static equilibrium thinking. This is Joseph Schumpeter’s theory of economic development from the beginning of the last century: companies compete for the highest productivity at given wages, i.e. for absolute advantages, which leads to a permanent development process. It is not financed from savings, but with money created out of nothing. However, the significance of this theory has never been fully understood and utilised for economic policy practice.
This means that the standard model of a macroeconomic production function is theoretically invalid. This is because a backward-looking substitution of capital for labour is ruled out. In other words, there is no market signal that could cause an entrepreneur to abandon a level of technology once it has been reached and move backwards, namely towards a technology that is less productive because it is more labour-intensive. The idea, fundamental to all standard macroeconomic models, that the supply of jobs in an economy is essentially controlled by the wage/interest rate ratio is therefore obsolete.
There is no conversion of saving into investment controlled by a market interest rate
The income of the corporate sector, the profit, is particularly exposed in a market economy. It is the residual income, i.e. the income that remains after all contractually agreed income has been paid. It follows that any attempt by another sector not to spend all the income it has received from companies (and the state as employer and transfer provider) means a loss for the companies. From a macroeconomic perspective, saving is therefore not a virtue, but a heavy burden on the economy. If one sector saves, there must be another sector that incurs the same amount of debt if the income of companies is to remain unchanged.
The neoclassical attempt to establish a balance between saving and investment (debt) with the help of a market interest rate ignores this compelling connection and is therefore untenable. One of the fatal flaws of this theory is the idea that competition will reduce all profits to zero in the long term and that they can therefore be left out of the explanation of market economy processes. Profits are the central motor of every market economy development. However, they are not generated by savings. Quite the opposite: Saving reduces profits and thus hinders a positive market economy dynamic. Capital is not created by trying to save more, but by a process in which – financed by money – all incomes can rise because productivity increases.
There is no wage-driven substitution between labour and capital.
Neoclassicism and thus neoliberalism are necessarily based on the idea of an overall economic labour market in which wages ensure a balance between job supply and job demand. In the case of unemployment, however, this only works if a wage reduction would cause all companies in a country to develop their technology backwards in the same way without any time lag. As mentioned above, this is impossible in a market economy that is constantly changing due to competitive pressure. You can see immediately that the neoclassicists and neoliberals have never understood the dynamic core of a market economy.
Contrary to what the neoclassicals claim, every wage reduction leads to a fall in demand and capacity utilisation in companies. As a result, companies lay off workers even though their wages have fallen. The supporters of neoclassical theory cannot find a convincing answer to this theoretically explainable and empirically proven phenomenon because it brings their entire theoretical edifice crashing down.
Money is important, but inflation is always and everywhere a wage phenomenon.
Neoclassical economics has no theory of inflation. Monetarism was used as a stopgap solution, i.e. the idea that controlling the money supply could also control inflation. This has failed. There is neither control of the money supply nor efficient control of inflation by the central bank.
Because only a process financed with money out of nothing enables positive economic development, it is essential to assign the control of the price level to another policy area. Due to the importance of wages for the costs of companies, this is income policy. Only if the state is able to establish a general consensus on an appropriate wage path (in which inflation remains low and real wages always rise at the rate of productivity growth) can monetary policy focus on promoting investment with low interest rates. China is the country that has succeeded in creating optimal investment conditions over many decades, while most developing regions, misguided by inappropriate economic theory, have failed to do so.
International trade is determined by absolute advantages and disadvantages; there are no comparative advantages that could be utilised by developing countries
Companies always fight for absolute advantages. It is therefore absurd to imagine that niches could emerge for developing countries in which industrialised countries have absolute advantages but are unable to exploit them due to a lack of capacity. The defence of this so-called theory of comparative advantage has again been based on assumptions that have nothing to do with the real world.
The consequences are devastating for developing countries. If we want to limit migration, we need to rethink how poorer countries can be truly integrated into the global economy, while at the same time stopping the destruction of our natural resources.
Capital markets, including cross-border financial markets, are never efficient, but destabilising
No less devastating are the consequences of the open capital markets propagated by the mainstream for all less established countries. It can be clearly shown that the international capital markets are failing in the task of ensuring an appropriate distribution and stability of financial flows. Herd formation by ‘investors’ regularly leads to incorrect prices and subsequently to major crises. As a result, the incorrect prices and miscalculations of large numbers of investors cause enormous damage. Government intervention is indispensable, especially on the currency markets.
However, international co-operation in this area is essential. Ultimately, a multilateral system is therefore necessary to ensure monetary stability in international trade and to give developing countries a real chance to integrate. Stable real exchange rates must be the goal.
The state must control the three macroeconomic prices, interest rates, wages and exchange rates, with the co-operation of the countries; at the same time, the price of fossil energy should be systematically pushed up by the international community in line with falling supply
The state has a genuine macroeconomic control task in the market economy. Because the decisive macroeconomic prices, wages, interest rates and exchange rates can never be efficiently formed on the basis of a microeconomic calculation, an enlightened state (or a community of states) must ensure that there are no major distortions in these prices.
In addition, the international community must come to terms with reducing the supply of fossil fuels to ensure that a global reduction in the consumption of these substances finally gets underway.