by Kate Raworth
For the twenty-first-century economic story, the state’s role must be rethought. 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.
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 like 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.42 In the words of Ha-Joon Chang, ‘If we remain blinded by the free market ideology that tells us only winner-picking by the private sector can succeed, we will end up ignoring a huge range of possibilities for economic development through public leadership or public-private joint efforts.’43 Such state leadership is now needed worldwide to catalyse public, private, commons and household investments in a renewable energy future.
The state as empowering, enabling economic partner: it sounds so good – is it too good to be true? That crucially depends, argue the economist Daron Acemoglu and political scientist James Robinson, on whether, in each country, the state’s economic and political institutions are inclusive or extractive. Put simply, inclusive institutions give many people a say in decision-making, unlike extractive ones that privilege the voice of the few and allow them to exploit and rule over others.44 The threat of the authoritarian state is very real, but so too is the danger of market fundamentalism. To avoid the tyranny of the state and the tyranny of the market alike, democratic politics are key – thus reinforcing the foundational role played by society in generating the civic engagement needed for participation and accountability in public and political life.
FINANCE, which is in service – so make it serve society
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.
First, contrary to the textbook story and the Circular Flow diagram, banks do not merely lend out the money that has been deposited by their savers. They create money from nothing each time they issue loans – recording on their books both a liability (since the loan is withdrawn by the borrower) and a credit (since the loan will be repaid with interest over time). Such credit creation is hardly new – it started several thousand years ago – and it can play a valuable role, but it has grown hugely in scale since the 1980s. That expansion was triggered by financial deregulation (think reregulation) – including the 1986 Big Bang in the UK and the 1999 repeal of the Glass–Steagall Act in the US – which ended the requirement for banks to keep customers’ savings and loans separate from their own speculative investments.
Second, financial markets do not tend to promote economic stability, despite the claims that they do. Thanks to financial deregulation, said US Federal Reserve Chair Alan Greenspan in 2004, ‘not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.’45 Four years later, the financial crash disproved that claim in a fairly decisive way. At the same time, Eugene Fama’s efficient-market hypothesis – that financial markets are inherently efficient – lost credibility and has been countered by Hyman Minsky’s financial-instability hypothesis – that financial markets are inherently volatile – as we will see in Chapter 4.
Lastly, far from playing a supporting role to the productive economy, finance has come to dominate it. In many countries, a small financial elite – based in just a handful of banking and financial firms – controls the public good of money creation and profits handsomely from it, while too often destabilising much of the wider economy in the process. It is time to turn this upside-down scenario the right way up and redesign finance so that it flows in service of the economy and society. Such a redesign also invites a rethink of how money could be created – not just by the market but by the state and the commons too – and Chapters 5, 6 and 7 explore some possibilities for that.
BUSINESS, which is innovative – so give it purpose
Operating within the realm of the market, business can be extraordinarily effective in combining people, technology, energy, materials and finance to create something new. The neoliberal narrative claimed that the market mechanism is what makes firms efficient, and so ignored what goes on inside them, just as it did with the household. But it is essential to lift the lid here too and look inside the black box of production.
Power is always at play between a firm’s waged workers and its shareholding owners because of the vast inequalities between them, as Friedrich Engels and Karl Marx witnessed in the squalid factories of Victorian Britain. Such conditions can still be found in factories and farms across the world today where, in the name of profit, managers routinely flout the law, for example by locking workers in, banning toilet breaks, or sacking women if they become pregnant. But even when businesses operate within the law they can, in many countries, hire workers on insecure, zero-hour contracts, while paying a legal minimum wage that leaves them living below the poverty line.46
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, as Chapter 5 explores. 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 and, as Chapter 6 illustrates, a growing number of enterprises are finding ways to give themselves one.
TRADE, which is double-edged – so make it fair
The Embedded Economy diagram could be used to depict a single nation’s economy, but it can likewise portray the global economy, and so includes international trade. Globalisation has led to the rapid expansion of cross-border flows in the last 20 years, thanks to shipping containers and the Internet slashing the costs of international transport and communications and, since 1995, thanks to the World Trade Organization’s agenda of trade liberalisation.
Ricardo’s influential theory of win–win trade was based on products like 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 cr
oss-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.
All of these cross-border flows have the potential to deliver benefits but they carry risks, too. When it is cheaper to import staple foods like rice and wheat than it is to grow them, trade can significantly reduce food prices for consumers. At the same time it may undermine domestic food production and leave the country highly vulnerable to international price hikes – as bread riots from Egypt to Burkina Faso revealed when the global price of wheat, corn and rice trebled during the food price crisis of 2007–8. When skilled workers migrate – such as doctors and nurses from sub-Saharan Africa working in Europe – they bring valuable skills and send much-needed remittances to their families back home, but this can also lead to a skill shortage in their own country’s core services. When corporations offshore manufacturing, it often delivers cheaper products to consumers and creates new jobs overseas. But it can also result in domestic job losses that decimate whole communities – as experienced in America’s ‘rust belt’, the nation’s former industrial heartland. Likewise, financial inflows may boost an emerging economy’s fledgling stock market but when international finance exits even faster than it entered, it can induce a near collapse of the currency, as Thailand, Indonesia and South Korea discovered the hard way during the Asian financial crisis of the late 1990s. Cross-border flows are always double-edged and so need to be managed.
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. Despite their current rhetoric of ‘free trade’, when it comes to trade negotiations almost all of today’s high-income countries – including the UK and the US – took the opposite route to ensure their own industrial success, opting for tariff protection, industrial subsidies and state-owned enterprises when it was nationally advantageous. And today they still keep tight control over their key traded assets such as intellectual property.47
Just as there is no such thing as the free market, it turns out that there is no such thing as free trade: all cross-border flows are set against the backdrop of national history, current institutions and international power relations. As the world’s 2007–8 food price crisis followed by the 2008–10 financial crisis illustrated, it requires effective cooperation among governments to make sure that the benefits of cross-border flows are widely shared.
POWER, which is pervasive – so check its abuse
Search for the word ‘power’ in the index of a modern economics textbook and – if mentioned at all – it will probably refer you to an analysis of electricity sector reform. But power is at play in myriad places throughout the economy and society: in daily household decisions about who cares for the kids; in boss-versus-worker wage negotiations; in international trade and climate-change talks; and in humanity’s domination over other species on the planet. Wherever people are present, so too are power relations: think of them as running throughout the Embedded Economy diagram, within each of its domains and at the interface between them too.
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. But, as the Occupy Movement made clear with its meme of the 1% and the 99%, that stylised picture doesn’t quite do justice to the reality we have come to know. Inequality amongst households and firms alike has soared in many countries in recent decades. And the extreme concentration of income and wealth – in the hands both of billionaires and of corporate boards – rapidly turns into power over how and for whom the economy is run.
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.48
In the US, private and corporate funding for elections has increased more than twentyfold since 1976, and it topped $2.5 billion during the 2012 Obama–Romney presidential race.49 Since 2005, the fossil-fuel industry alone has spent $1.7 billion in the USA on lobbying and campaign contributions, which explains their entrenched political support. In Europe, the EU–US Transatlantic Trade and Investment Partnership (TTIP) – a proposed trade treaty promising private court hearings for American and European corporations wishing to sue each other’s governments – was drawn up under the heavy influence of big business. In 2012–13, as treaty discussions got under way, over 90% of meetings held by the European Union – 520 out of 560 – were with corporate lobbyists.50 Such examples simply add to the reasons why, in the twenty-first-century story, the economy must be designed to be far more distributive not just of income but also of wealth, as Chapter 5 explores, in order to counter elite power with citizens’ empowerment.
Raising the curtain on a twenty-first-century story
Stand back, survey the whole stage and the new cast of characters that this chapter has introduced: what difference does it all make? Simply putting aside the Circular Flow diagram and drawing the Embedded Economy instead transforms the starting point of economic analysis. It ends the myth of the self-contained, self-sustaining market, replacing it with provisioning by the household, market, commons and state – all embedded within and dependent upon society, which in turn is embedded within the living world. It shifts our attention from merely tracking the flow of income to understanding the many distinct sources of wealth – natural, social, human, physical and financial – on which our well-being depends.
This new vision prompts new questions. Instead of immediately focusing on making markets work more efficiently, we can start by considering: when is each of the four realms of provisioning – household, commons, market and state – best suited to delivering humanity’s diverse wants and needs? What changes in technology, culture and social norms might alter that? How can these four realms most effectively work together – such as the market with the commons, the commons with the state, or the state with the household? Likewise, rather than focusing by default on how to increase economic activity, ask how the content and structure of that activity might be shaping society, politics and power. And just how big can the economy become, given Earth’s ecological capacity?
At the end of Shakespeare’s Tempest – when all wrongs have been righted – Prospero’s daughter Miranda, who has lived a cloistered life on the island with her father, sees for the first time the scheming noblemen of Milan who were shipwrecked by the storm. ‘Oh, wonder!’ she exclaims, ‘How many goodly creatures are there here! How beauteous mankind is! O brave new world / That has such people in’t!’ Twenty-first-century economists might share her wonder, but without her political naivety. Having been cloistered for seventy years within the confines of Samuelson’s insular Circular Flow diagram and the Mont Pelerin Society’s narrow neoliberal script, we can now start writing a new story simply by picking up a pencil and first drawing the Embedded Economy. And since this big-picture perspective puts the econom
y in context, it is far easier to see some of the big questions that the twenty-first-century economist must tackle. There’s just one thing still missing and that is the play’s protagonist: humanity.
3
NURTURE HUMAN NATURE
from rational economic man to social adaptable humans
Think of the most famous portrait ever painted. It has to be the Mona Lisa, the enigmatic painting by Leonardo da Vinci that is reproduced on postcards and fridge magnets the world over. Leonardo was a master in oils but he was a pioneer of pen-and-ink sketches too. While people-watching in the streets of Milan he invented the art of caricature, those ‘loaded’ portraits that intentionally exaggerate a person’s most distinctive features – be it a bulbous nose or protruding chin – to produce an image that, comic or grotesque, bears an unmistakable likeness to its model.
The Mona Lisa may top the list of famous portraits but it is far from the most influential one. That accolade belongs to an equally enigmatic yet utterly different character who more closely resembles one of Leonardo’s caricatures. He is, of course, rational economic man, the self-centred depiction of humanity at the heart of economic theory, who is also known as Homo economicus (note how the Latin touch lends him an air of scientific credibility). His image has been drawn and redrawn over two centuries by successive generations of economists, and over time has become so exaggerated and embellished that what had started out as a portrait turned into a caricature and ended up as a cartoon.1 Despite his absurdities, however, rational economic man’s influence goes far beyond fridge magnets. He is the protagonist in every mainstream economics textbook; he informs policy decision-making worldwide; he shapes the way we talk about ourselves; and he wordlessly tells us how to behave. Which is precisely why he matters so much.
