In Part II, we discussed the principles and consequences of Modern Monetary Theory (MMT). This week’s installment will be devoted to the importance of paradigms. Next week, we will conclude the series with a discussion on the potential flaws of MMT along with market ramifications.
The Importance of Paradigms
Every major shift in the efficiency/equality cycle has coincided with a favored economic theory to promote the change. The following chart from Peter Turchin shows his take on inequality and wellbeing cycles in U.S. history. Although Turchin doesn’t fit his pattern to Arthur Okun’s equality and efficiency tradeoff, we see a strong match between this tradeoff and Turchin’s wellbeing and inequality cycles. During periods where Turchin’s wellbeing line is rising and inequality is falling, the economy is going through an equality cycle. Equality cycles are sometimes characterized by policies that favor labor (which may include high marginal tax rates, easy monetary policy, policies that favor unions and social mores that promote “the common man”).
Usually, equality cycles end when the economy needs to build productive capacity to reduce inflation and thus needs to increase efficiency. These are policies that favor capital, which may include low or non-existent tax rates, reduced regulation, anti-organized labor policies and social mores that lionize wealth.
(Source: Peter Turchin)
Our historical analysis suggests there have been four shifts in equality and efficiency and each has been supported by an economic theory that gave intellectual credence to the shift.
Classical Economics and the Industrial Revolution. The Industrial Revolution was the original “move fast and break things.” New technologies were applied to manufacturing, transportation and agriculture. The economics of Adam Smith to Alfred Marshall argued for limited government and suggested that self-interest, left unfettered, would lead to the best outcome for society. For the classical economists, the economy is self-regulating and thus outside influences, such as government, disrupt the natural rhythms of the market. One of the key theoretical constructs was “Say’s Law,” which argued that supply creates its own demand. If prices can rise or fall to their correct level, then everything produced will be consumed. This means that resources will always be fully utilized. The period, which began around 1820 (in England) and continued into the early 20th century (as it spread to continental Europe, the U.S. and Japan), led to the building of the industrial base across the West and Japan. However, it also led to significant social ills and rising inequality. Western nations attempted to deal with the inequality through expanding suffrage, implementing income taxes, child labor laws and antitrust legislation, but inequality remained high. The Great Depression marked the end of the Classical era and the Industrial Revolution.