Phelps on What is Wrong with the West’s Economies

August 5th, 2015
in Op Ed

by Dirk Ehnts, Econoblog101

The New York Review of Books carries an article by Edmund Phelps.  This is how he ends it:

Of the concrete steps that would help to widen flourishing, a reform of education stands out. The problem here is not a perceived mismatch between skills taught and skills in demand.(Experts have urged greater education in STEM subjects-science, technology, engineering, and mathematics-but when Europe created specialized universities in these subjects, no innovation was observed.)

Follow up:

The problem is that young people are not taught to see the economy as a place where participants may imagine new things, where entrepreneurs may want to build them and investors may venture to back some of them. It is essential to educate young people to this image of the economy.

It will also be essential that high schools and colleges expose students to the human values expressed in the masterpieces of Western literature, so that young people will want to seek economies offering imaginative and creative careers. Education systems must put students in touch with the humanities in order to fuel the human desire to conceive the new and perchance to achieve innovations. This reorientation of general education will have to be supported by a similar reorientation of economic education.

We will all have to turn from the classical fixation on wealth accumulation and efficiency to a modern economics that places imagination and creativity at the center of economic life.

While I am quite sympathetic to these ideas, I do not think that the low economic growth (and high unemployment) in the West's economies are caused by slow productivity growth. Instead, the problem is slow wage growth and thus lack of domestic demand (source: Wikimedia):

Productivity_and_Real_Median_Family_Income_Growth_1947-2009

The numbers are quite similar for Japan (stagnant wages for more than a decade) and Europe (austerity and wage cuts in the periphery). If production increases by something percent but wages do not increase at all, the wage earners will not have enough purchasing power to absorb the whole production. There are three ways out:

  1. Move into debt to keep up with the Joneses
  2. Export, export, export
  3. Do not increase production
  4. Let wages increase more

It should be obvious that strategies 1-3 are not sustainable. Private debt cannot rise forever, foreign debt cannot rise forever, and a zero growth economy with rising productivity and ever-rising inequality surely will lead to political turmoil.

Theoretically, an increase in government spending could also fill the gap in demand. However, this very likely will lead to higher wage increases in the medium to long-run and thus a temporary stimulus should be enough. (The structural problem in the background seems to be that the shortfall in demand caused by the lack of wage increases is not made up by higher demand caused by the rise in profits.)

If an increase in government spending is part of the solution, I would then agree with Phelps on this paragraph:

It will also be essential that high schools and colleges expose students to the human values expressed in the masterpieces of Western literature, so that young people will want to seek economies offering imaginative and creative careers. Education systems must put students in touch with the humanities in order to fuel the human desire to conceive the new and perchance to achieve innovations. This reorientation of general education will have to be supported by a similar reorientation of economic education.

(... and, by the way, I am glad to work at Bard College Berlin - A Liberal Arts College, where we are already have a BA program along those lines. Our BA in Economics, Politics and Social Thought has lifted off in September 2014.)









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