Major Issues where Mainstream Economists Failed - Part 1

In the last blog, I examined the President of Ireland's speech critical of the lack of heterodoxy (or differences) in Irish economics. I argued that while the mainstream economic policies pursued in Ireland had led to substantial economic development and also in improved life satisfaction in recent decades, there were times, especially in the 2000s. when the dominant neo-classical economics was heavily influenced by the more extreme neo-liberal ideology. Neoclassical economics is largely conservative, focusing on the market and so tends not to challenge the status quo.

However, on top of the avoidable economic Crash in 2008, there were several major economic issues which were not being addressed by policies and so some were and are still unresolved. The following, in my view, are a dozen major issues that mainstream economists failed, or are/were slow to see or adopted incorrect responses to, largely because of their neo-classical orthodoxy:

1. The Crash of 2008
2. The Response to the Crash - Austerity
3. The EU Fiscal Rules - Enforced, Europe-wide Austerity
4. Privatisation
5. The Neglected Role of the Governance of Firms
6. Banking  - Private Gains and Socialised Losses
7. Housing
8. Inequality
9. Technology is not neutral
10. Globalisation
11. Climate Change
12. GDP and Growth

 I examine the first six here.

1.         The Crash of 2008

Most Irish economists could not see the financial, tax-driven property bubble in the 2000s which imploded in the huge Crash of 2008 Ireland. This global Financial Crash nearly destroyed Capitalism itself. Ireland had one of the worst crashes thanks to the tax cutting and low regulation  polices pursued by its most neoliberal Irish government, from around 2001.

Few economists here advocated strong bank regulation and did not see the consequences of the tax incentivised property boom in the 1980s. For example, the National Competitiveness Council which advised government on business and economics called for less regulation and greater competition, particularly in banking, in the middle of the bubble in the mid-2000s. Only two members (both trade unionists, including the present author) of that Council disagreed with the orthodox view. It was obvious then, to some of us, that there was there was unregulated oligopolistic competition when the banks were falling over each other to lend vast sums of money to people who could never afford to pay it back. The Financial Regulator was asleep but the market was booming and getting "boomier".

2.         The Response to the Crash - Austerity

The response to the 2008 economic crash was austerity - to take demand out of the economy, when firms and individuals were also tightening their belts. It was the exact opposite of what should have been done. Many later called it "group think' but it was simply economic orthodoxy.

Yet there was another view: in Ireland early in 2009 ICTU proposed a policy alternative to austerity called "There is a better Fairer Way." Congress proposed this and other alternative strategies to Govt and to the Troika at meetings in the three years of bailout. Austerity ruined many jobs, businesses and hurt the poorest most.

It is now widely recognised eg Blyth or OECD that austerity was not the best way to deal with the crisis. Even conservatives in the ECB argue eg "Does Austerity Pay Off" that cuts can be made in benign times but not during a severe crisis.

3.         The EU Fiscal Rules - Enforced Europe-wide Austerity

In the European Union the key driver in the pursuit of the wrong response - austerity - to the financial crisis in 2008 was the EU's own Stability and Growth Pact (SGP). I have critiqued it in these blogs. It was finally abandoned in the face of reality when recognised as being deeply flawed. It is being reformed but not adequately as Robert Sweeney (no relation) shows.

4.         Privatisation

The privatisation of public assets and services is a much bigger issue than most people are aware of. It is a vital issue in a modern society where the interdependence of the public sphere and the market is crucial for a functioning society. Yet privatisation is not seen as an issue for mainstream economists. It is viewed as neutral - as merely a change in ownership, that it might lead to improved or cheaper goods and services. But privatisation of the public sphere is more insidious, costly and has had a deeper impact on the lives of the public than anyone anticipated, including the widespread provision of privatised, poorer public services.

The biggest privatisation in the UK and here was the sale of the vast stock of public housing. These houses were sold well below market prices and were the precursor of the current housing crisis. From the 1970s there was little dissent from mainstream economists, strongly influenced by Finance Capital, to the neo-liberal idea that the provision of public-housing was no longer necessary. This was because, it was argued, the poorest people could now afford to buy their own homes, aided by cheap loans provided by what were to be the dodgiest financial outfits (most of which collapsed).

The origin of the idea was from Margaret Thatcher with her stated far-right political objectives  including shrinking the state - by cutting taxes and by privatisation. Privatisation peaked in the 1990s but it is still around in many new forms such as Public Private Partnerships, outsourcing, and now selling state control of the biggest retail bank, AIB etc.

The outsourcing of many public services including even of policy-making in the civil service is prevalent, as Mariana Mazzucato/Collington have shown in their recent book, the Big Con. This issue is not even on the horizon for many as the management and policy-making skills of civil services in the EU are eviscerated. The recent revelation that the Department of Transport has spent up to €300m on consultants on the non-existent (after decades) Dublin Metro demonstrates the growing privatisation of policy and strategy. Spending hundreds of millions on consultants instead of developing a strategy in-house to deliver an integrated public service in a capital with the poorest public transport is urgent. Governments need to curb consulting and insource strategy and oversight.

5.         The Neglected Role of the Governance of Firms

Mainstream economists ignore vital economic issue of the workings/governance of firms, of multinationals. However, the one economist who did not ignore this area was the father of neo-liberalism, Milton Friedman. His radical theory of the firm promoted the idea of "shareholder value." This idea of the governance of firms was to radically change the way in which companies operated, ultimately leading to the crash of 2018. Profit, was king, costs including even paying tax (after profit!) was to be avoided and  short-termism was enhanced.

This view dominated the way firms worked and still does. However, in 2019 the Roundtable of Business in US proposed the rejection of this theory of shareholder value espoused by the founder of neo liberalism. The US Roundtable wanted to focus on stakeholder value, which means the emphasis shifts from one powerful group, the shareholders, to all stakeholders: workers, community, state, customers, environmentalists, etc. However this has not yet happened, vividly illustrated by the boss of Shell recently promising to ruthlessly focus on fatter shareholder returns, neglecting stakeholders other than shareholders, including those concerned about climate change. Profit maximisation is still dominant and it is leading to major consolidation of companies, and also to the dominance of private equity. It could lead to capitalism collapsing again and the need for it to be rescued again by the state.

6.         Banking  - Private Gains and Socialised Losses

The financial crisis in 2008, when many banks collapsed and were rescued by taxpayers showed that banking is too important to be left in the hands of private individuals. The response to the crisis was much stronger regulation of banking. This was implemented in most countries. However, better regulation on its own is not sufficient. It did not prevent further banks collapsing in various countries such as Credit Suisse in Switzerland and a substantial list of nearly 600 US bank failures from 2000, most since the tighter regulation after the 2008 Crash. More recently in 2023 we had the collapse of Silicon Valley Bank and only two days later First Republic and also Signature Bank.

Banking is not neutral either and it is too important to be left in the hands of individuals who follow 'shareholder corporate governance' which is contrary to the common good. On top of good regulation the state needs to be directly involved in banking. In Ireland today, the biggest retail bank AIB was rescued by full nationalisation. But the state holding has been cut to under 50% today - without any debate on its future governance.

Mainstream economists are indifferent to the form of bank (or firms) governance, genuinely believing Central Bank regulation with decent capital ratios will prevent the next collapse. This is naive and will be costly. Why? Because, as was seen, many banks have collapsed since the strengthened regulation.  There must be a switch to stakeholder capitalism and a substantial (not less than 33% in my view) state holding in key Irish retail banks like AIB. This minority holding must ensure that serious public interest directors are put in place. They must not be from Big Law or Big Accounting. Both "professions" were heavily involved before the collapse,  giving no warnings of the pending collapse of banks and property speculators. They then made another packet cleaning up the mess. State holdings in banks and stakeholder governance will help end the era of private gain and public losses.

The level of state intervention to rescue the financial sector here, the US and everywhere has been unprecedented. It has undermined any idea of private market superiority over the public sphere. Greater recognition of this interdependence should make for better policy.

In the next blog, we will examine six more major issues that mainstream economists failed to see coming or in my opinion adopted the incorrect responses.

Posted in: Banking and finance • Corporate governance • Economics • Fiscal policy • Housing • Inequality • Politics • Taxation

Tagged with: banking • corporategovernance • fiscalrules • globalisation • housing • inequality • privatisation

Paul Sweeney     @paulsweeneyman

Paul Sweeney is former Chief Economist of the Irish Congress of Trade Unions. He was a President of the Statistical and Social Enquiry Society of Ireland, former member of the Economic Committee of the ETUC, a member of the National Competitiveness Council of Ireland, the National Statistics Board, the ESB, TUAC, (advisor to OECD) and several other bodies. He has written three books on the Irish economy and two on public enterprise, including The Celtic Tiger; Ireland’s Economic Miracle Explained and Selling Out: Privatisation in Ireland, chapters in other books and many articles on economics.