The Economic Imbalances of our Time and the Perspective of Circular Economy

Please cite the paper as:
Arturo Hermann, (2018), The Economic Imbalances of our Time and the Perspective of Circular Economy, World Economics Association (WEA) Conferences, No. 2 2018, The 2008 Economic Crisis Ten Years On, 15th October to 30th November, 2018

Abstract

The main aim of this work is to make a step in identifying the theories more adequate to understand the economic imbalances of our time, and more conducive to realise the objectives of a “circular economy”. These objectives can be articulated in progress (scientific and social), sustainability and social justice (PSS).
One reason for this exercise lies in the circumstance that there seems to be little synergic employ of the theories that can help explain the imbalances of our economies and the possible ways to overcome them. This is a typical problem of economics and other social sciences, which often tend to be rather fragmented.
In this regard, we have tried to build a stronger bridge between environmental economics, and a number of heterodox theories of economic imbalances that can make headway to devise a more effective and coordinated policy strategy. In particular, we employ these theories for analysing how to render more and more compatible the objectives of (i) full employment (however defined) and decent work; (ii) sustainable use of resources in all its forms; (iii) substantial reduction of economic and social inequalities; (iv) human, scientific and technological progress.

In the first chapter we analyse the systemic tendency of effective demand to lag behind the supply of full employment. The analysis of these aspects, we believe, is pivotal also for a better integration between environmental and macroeconomic objectives.

In the second chapter we address the main strands of environmental economics. We consider in particular the perspective of bioeconomy, the theories of “commons” and of “appropriate technologies”, and the various forms of ecosocialism, with an eye to their policy implications.

In the third chapter we appraise the contribution of institutional economics to the clarification of (i) the institutional and evolutionary nature of economic action; (ii) the need of an interdisciplinary approach for a better understanding of these phenomena; (iii) the potential of democratic planning for overcoming the failures of the state and of the market; and (iv) the role of social valuing for promoting an effective policy action.

In the final part we consider how these theories can jointly be employed for addressing in theory and policy action the objectives indicate above.
We underscore that such theories, however different in many respects, present notable complementarities, in the sense that the aspects more overlooked by some are more completely considered by the others.
As observed by the famous sociologist Karl Mannheim, a landscape can be seen only from a determined perspective and without perspective there is no landscape. Hence, observing a landscape (or phenomenon) from different angles (or disciplines) can help to acquire a much clearer insight into the features of the various perspectives. Hence these theories, by helping identify the manifold aspects of economic system, can make headway towards a more effective policy coordination. This would involve a horizontal level, between policies: in particular macroeconomic (fiscal and monetary) and structural (in particular, environmental, industrial, research and innovation, social). And a vertical level, between institutions (supranational, national, sub-national, local).
Such coordination would be greatly fostered by a process of social valuation involving all the considered dimensions of policy action.

Recent comments

7 Comments ↓

7 comments

  • Fernando Centeno says:

    Instead of front-end efforts to better understand theories, practices, initiatives, etc. we need instead to focus on the back-end of actual impacts and outcomes from the vast store of investigative research already carried out over many years. What are the results of these thoughts, ideas, theories, plans, and systems? Who carries the weight of success along any dimension of thought and study?

    We always seem to start anew, rather than coming to terms and understanding of what was most productive, efficient, and effective. I’m interested in this expertise, rewarding those who have walked the walk, to relative or actual fruition. Is this asking too much?

  • Arturo Hermann says:

    Hi Fernando, the problem (or opportunity) lies in the circumstance that the theoretical framework for addressing economic crisis is far from being settled in theory and policy action. So, according to which theory should we walk the walk?

  • Alicia Green says:

    In the paper you stress the importance of a better coordination between policies and institutions for improving the effectiveness of policy action.
    How such coordination can be realised in real situations, often characterised by conflicting views/interests?

  • Arturo Hermann says:

    You raised a significant issue, which relates to the types of public sector intervention in the economy. Should it exist at all, and, in the affirmative case, what kind of economic intervention (or planning) is preferable?
    As I have tried to show, the conception of the market system as a perfect and optimising mechanism and/or leading to a “spontaneous order” à la Hayek is a kind wishful thinking. What comes about in real economies is that markets are created and maintained by an evolving set of law, institutions and policies most often oriented by the stronger groups. Furthermore, various kind of public goods cannot be delivered by the market and then require a direct public action.
    For these reasons, some kind of economic planning is always necessary for attaining the objectives of policy action and for the very working of the market system. I shift then to the second question, namely, as to what kind of economic planning is preferable.

    In this respect, a useful taxonomy has been provided by Original Institutional Economists (for instance, William Dugger, Marc Tool, Harry Trebing), which identify three types of economic planning..
    The first type is “corporate planning”, which is the reality of modern capitalism. In this system, the working of “free market forces” is heavily conditioned by the interests of big corporations. Corporate planning is highly hierarchical, since the key decisions are made by top managers with little involvement of workers and citizens at large.
    The second form is totalitarian planning, characterised by a public purpose which is pursued through a highly hierarchical structure.
    Government members are appointed by the ruling (and most often single) political party. In such instances, there is no guarantee that (i) the party is organized democratically and expresses the needs and experiences of all the groups and classes of society; and (ii) that government members and public officials are really accountable for their behaviour.
    Such system ─ no matter how good its abstract ideals can be ─ is flawed by a lack of accountability and democratic representation.

    The third form is democratic planning. This alternative, although it does not always work miracles, is definitely more promising. By allowing a more complete expression of the experiences, motivations and conflicts of the involved subjects, such system improves the process of social valuation, and then the capacity of policy action to respond to the profound needs of society.
    One central difference of democratic planning in respect to corporate and totalitarian systems resides in a better capacity to self-correct ─ by a process of trial and error ─ its own shortcomings.

    In this respect, democratic planning can find application to a wide array of contemporary issues, often reaching out to a supranational dimension. These include the building of peaceful relations, the reduction of gross inequalities between persons and economic areas, and, as a central theme tied to the previous issues, the solution of the environmental problems.
    In these and other issues, institutionalism can usefully interact with other heterodox fields of economics ─ in particular, Marxism and other theories of socialism, Keynesian and environmental economics ─ for devising a progressive course of policy action.

  • Antonia Bianchi says:

    For instance, how can democratic planning be applied to some “hot issues”, like public debt sustainability?

  • Arturo Hermann says:

    In discussing sustainable issues with some colleagues, they wondered how underconsumption theories can be related to the notion of circular economy. After all, does not underconsumption theories advocate more consumption (with little environmental concerns) to attain full employment? The latter aspect is partly true, but it is also true that such theories (rather overlooked), by casting light on various contradictions of capitalism, can help devise better sustainable policies.

    But what are, in a nutshell, the distinctive aspects of underconsumption theories? They underscore, although with various differences between their analyses, that the crucial feature of capitalistic economies is a structural tendency towards underconsumption in respect to the level of full employment (however defined). To any level of underconsumption corresponds an over-saving in respect to the level of investment into which it can be channeled.
    There are several reasons for these phenomena: (i) the lower propensity to consume of the richer people which, especially in presence of an unequal distribution of income, tends to reduce the amount of aggregate consumption; (ii) if this takes place, an increased amount of investment cannot make up for less consumption; in fact, since investment expenses are instrumental to consumption, they must bear a well-defined relation with the production of consumption goods; (iii) these aspects are reinforced by the tendency, especially in times of boom, towards over investment and multiplication of firms, with consequent excess of productive capacity (an aspect also underscored by original institutional economists, to whom underconsumptionists were fairly related).

    In this respect, “depression in trade and excessive thrift are terms describing different phases of the same phenomenon.”, F.A.Mummery and J.A.Hobson (1889), “The Physiology of Industry”, London, John Murray, reprinted in 2015 by Leopold Classic Library: 98.

    The process leading to this result is located in the spirit of competition (and/or Keynesian “animals spirits”). In fact, whereas the aggregate saving is necessarily bound by the aggregate income, an individual is always free to save more in order to invest more. But, if the effective consumption is not sufficient to absorb the new productive capacity, the result is a general over-production.
    In order to illustrate how this process works, the authors make the example of a competitive examination for a dozen of skilled jobs for which the passing mark is 60(%). In these conditions, the sufficient requirement for covering the positions is that twelve candidates participate with a mark of 60 for a total score of 720. Normally, however, many more candidates participate, and often get a score higher than a simple pass. If, for instance, 50 candidates get an average score of 80, the total score will be 4.000. In this case, all the extra work of the candidates, which is equal to 3.280 (4.000 – 720) will be “overproduction”, namely a result totally useless for the examination purposes. In this respect, “each candidate has, or thinks he has, a chance of success, and this chance stimulates him to work.”, (ibidem: 115). This incentive will be reinforced, up to a certain point, when the chances of success are smaller.
    This example vividly illustrates a similar trend taking place in the marketplace: also here the normal condition is a general over-production and/or excess of productive capacity. We can note this phenomenon virtually everywhere: it suffices to go out for a walk to note that in shops, restaurants, hotels and the like the offer of goods and services all the likely far exceed what is demanded by consumers. We can find the same tendency in the industrial and agricultural production, where in the former predominates an excess of productive capacity whereas in the latter an excess of production.
    This phenomenon is particularly relevant in theory and policy action, and was underscored also by many contributions of original institutional economics and Keynesian theories. In fact, by providing a much more realistic picture of how the market economy works in practice, these contributions allow to realize that the market is not an abstract and optimizing mechanism but an institution created and maintained by public intervention.

    This invites a related question: can price mechanism equilibrate the market at full employment level (however defined)?
    This issue lies at the crux of economic theory: in fact, if we suppose that price mechanism can equilibrate the market at an optimal level, this implies that neoclassical economics substantially holds true and that, hence, the sound policy prescription should be one of laissez faire.
    In this regard, the authors, by grounding their analysis in the observation of real economies, thoroughly criticize the neoclassical account. They note that, in presence of an over-supply, a corresponding reduction of prices would not clear the market at full employment level.
    The reason for this is that a reduction of prices will also bring down the sellers’ income, and so the net effect on demand tends to vanish. This effect is supposed to hold true even if additional demand would perfectly make up for price reduction─namely, if the elasticity of demand is equal to one. This happens because this effect will unfold only in the long run and hence will not impinge on the reduction of income in the short run. Furthermore, a reduction of prices, if stimulates additional demand, is also likely to bring prices up again at the former level.
    In short, prices are not reduced simply because it is not profitable to do so. This comes about also because effective demand, while being fairly elastic upward, is most often notably inelastic downward. For a host of economic and psychological reasons, consumers tend to be much more alert and sensitive to a price increase than to a lack of price decrease when costs diminish. Hence, if firms cut down prices, this is unlikely to trigger a relevant increase in sales. The reason for this can be related to (a) asymmetrical information, in the sense that, also at psychological level, high prices tend to be considered as a “signal” of high quality. Hence, any reduction tends to be interpreted very suspiciously, as an admission of low quality and failure. Another reason for this inelasticity can be traced to (b) the satiation for many products and services. This takes place in particular for items which require an active involvement of consumers. For instance, if prices are halved the ordinary citizen is unlikely to buy, instead of two, four iPhones, four concerts, four coffees or four kilos of tomatoes.
    It is on account of these phenomena, then, that prices are more likely to be sticky or, even if flexible, are unable to equilibrate demand and supply at full employment level.
    These theories have also contributed to explain the sharp rise of the ratio private debt/GDP as a way to sustain effective demand. And why this trend, while worsening environmental sustainability, has failed to attain any equilibrium of full employment.

  • Arturo Hermann says:

    Dear Antonia, I think that democratic planning ─ however sharing the intrinsic imperfections of human ventures ─ can help deal with the most problematic social issues (for instance, unemployment, inequalities, migration and, of course, public debt). In fact, by providing an institutional setting for expressing and comparing ─ in a kind of collective psychoanalysis ─ conflicting views and interests, it constitutes the best antidote against intolerance, xenophobia and “anomie” in social life.

    As for your question, a proposal advocated by various observers consist in “debt monetization”, whereby the state “prints the currency” and provides it to creditors in payment of the debt. This, however, is nothing more than a return to the classic seigniorage power, which gave the state the power to print money to “finance” its expenses. What are the effects of this proposal, on which there is a heated debate? Would it trigger uncontrolled inflation/panic or boost the economy? In my humble opinion, none of these effects would ensue, but would only result in another speculative bubble, with modest effects on the real economy. In fact, if the “fundamentals” of the economic system do not change, what could traders ever do with “fresh money” if not to reinvest it in large part in securities and in newly created public debt?

    A related idea pertains to debt cancellation as a radical solution to such problem. This can be done, of course, but also in this case risks to produce “much ado about nothing” if the fundamentals of the system remain unaffected.
    Most often these ideas are accompanied ─ in particular in Europe, and as a way to get rid of the power of financial institutions ─ by the proposal to leave the euro and the EU and institute a national currency emitted by the State and /or the Central Bank.
    I need not spend many words for stressing that such nationalistic wave would not solve structural problems. Rather, it is likely to worsen them by rendering a fragmented Europe much weaker in the face of financial speculation and of strong players like the US, Russia, China.
    In this respect, the relevant objective is not to repay public debt ─ as noted elsewhere, public and private debts tend to be, rather than repaid, refinanced/consolidated over time ─ but to make it sustainable, that is, to ensure that its share of GDP remains stable or decreases gradually. This is achieved when,

    1. ΔY/Y ≥ ΔD/D

    2. with ΔD/D = µ(Y/D) + I with µ = (G – T)/Y

    where ΔY/Y is the growth rate of real GDP, ΔD/D the growth rate of debt stock, G the public expenditure and T the taxation, µ the ratio of primary deficit on GDP, i the real interest rate. It is clear that as long as the sum of a primary deficit and of the real interest rates remains relatively high, not only will the debt remain unpaid, but it will increase over time.
    But what are the effects of real interest rates and of the primary deficit on GDP? As shown by numerous contributions, high real interest rates have a negative effect on GDP, because the so-called marginal efficiency of capital shrinks (the differential between expected rate of profit and real interest rate). This comes about also because high real interest rates engender an increase in the cost of money for firms, which is most often accompanied by “credit rationing” to the disadvantage of small and medium-sized firms. And, last but not least, high real interest rates contribute to disseminating the “psychology of financial rent” to all social classes.
    Budget deficits have an expansive effect, because they “create” effective demand. However, deficit spending policies, although preferable to “austerity” policies, have the serious shortcoming of fueling the debt and interest payments spiral. Since also a balanced budget has expansive effects, it is much better to reduce the budget deficit to 1%-2% (or less).
    It would therefore be desirable that public spending be efficient within a principle of subsidiarity and complementarity with private action, and that taxation be fair and actually progressive for higher incomes.
    The real revolution to reduce the burden of public debt, and set the economy to an independent (in particular of powerful financial institutions) and brand new life, would consist in, (i) permanently reduce real interest rates; (ii) permanently reduce the budget deficit; (iii) set precise limits to speculative finance; and (iv) orienting banking activity to the actual support of productive and social activities, in particular of small and medium-sized firms.
    These measures become all the more pertinent on account of the structural tendency of economic systems to move towards steady state (and possibly de-growth). This being the case, the sum of primary deficit and of real interest rate must converge towards zero in order to keep stable (and substantially abate in in the mid-long run) the ratio public debt /GDP. Hence, the structural solution of public debt problem will go in tandem with the realization of a balanced, equitable and sustainable economy.