People evaluate their country’s economic performance on the basis of the social quality of economic growth—its effect on the standard of living of their household and community. By contrast, economists and the politicians they advise have been trained to focus primarily on the quantity of growth—the volume of goods and services produced at a national level as measured by gross domestic product (GDP). These are related but distinct phenomena, and the relationship between them has weakened in many countries, in fact as well as social perception.
This widening disconnect is creating a growing social and political headache for the diverse range of governments that apply the teachings of liberal economics. For the past half-century, most have been advised to focus on boosting their overall national income or GDP through strategies that improve the efficiency of resource allocation: fiscal and monetary discipline; flexibility of labour and product markets; financial deregulation; trade liberalization; international capital mobility and exchange rate flexibility; and privatization. These are tools for improving market signals, efficiency of production and accumulation of tangible capital as a means of expanding the size of an economy.
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An implicit assumption of this economic doctrine is that broad progress in living standards flows naturally from greater economic efficiency and the larger national and world economy it creates. The social benefits of expanded economic growth inevitably trickle down and out to the populace at large. This assumption is reinforced by the use of GDP as the standard basis for measuring a country’s annual economic performance and its overall level of development, even though neither of these concepts is synonymous with what GDP actually measures: the aggregate production of goods and services measured at market prices.
In effect, generations of Western and other liberal economists and policymakers have been trained to behave as if Adam Smith’s “invisible hand” of market-based resource allocation can be relied upon to optimize not only the wealth of nations (its core function as stated by Smith) but also the well-being of their populations at large. A rising tide of GDP, as it were, ultimately lifts all boats. But Smith and other important pioneers of the field assumed no such thing. They believed that market-oriented measures to increase the production and wealth of nations were a necessary but by no means sufficient condition for raising the broad standard of living of their people. A range of institutions—legal and other norms, policy incentives and administrative capacities mainly but not only in the public sector—were required to ensure broad social participation in the process and benefits of economic growth.
This excessive faith in markets and chronic underinvestment in institutions were embodied in the extreme in the most recent major course correction of liberal political economy—the wave of market liberalization that began in the late 1970s and 1980s and is often referred to as “neoliberalism”. It has been a hallmark of international economic cooperation, as manifested in the proliferation of free trade agreements and international investment treaties focused almost exclusively on market access. Countries have integrated product, capital and labour markets nationally, regionally and globally through domestic regulatory reform and international trade and investment liberalization on the implicit assumption that the resulting boost in growth will have a positive downstream effect on the living standards of their populations.
However, in many countries this approach has collided with three socioeconomic realities. First, although economies have indeed responded to this policy mix and expanded significantly in size, inequality has often also grown and median living standards have stagnated as the distribution of national income has shifted appreciably from labour to capital. Second, this same policy mix has brewed a triple cocktail of human dislocation and insecurity in the form of accelerated industrial restructuring driven by technological disruption, increased trade and investment flows propelled in part by labour and tax arbitrage, and domestic deregulation and privatization. Third, the chickens have come home to roost regarding the long-standing failure of economies to internalize the large negative environmental externalities of industrial development. Environmental degradation has reached a tipping point in many ecosystems, with adverse consequences for social and political order in a growing number of countries that these ecosystems host.
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These trends have combined to fuel a growing discrepancy between standard economic and financial measures of national economic performance (e.g., GDP and asset prices) and others more relevant to the everyday life of people (e.g., household income, access to decent work, level of social security). This disconnect between national income and household lived experience, between the wealth and broad living standards of nations, risks growing even wider over the next twenty years as artificial intelligence and algorithmic automation further disrupt manufacturing and service industries and governments implement tougher measures to decarbonize energy and industrial systems in line with their commitments under the Paris climate agreement.
Establishment politicians of the centre-right and centre-left have often appeared flat-footed in the face of these trends. Doubling down on more-of-the-same deregulatory and cost-of-capital-centred trickle-down economics increasingly resembles feet-of-clay economics to citizens, since it tends to widen rather than reduce this disconnect and exacerbate inequality. Large fiscal and monetary stimulus in the near term coupled with goals and targets for fundamental reform over the long term do not inspire great confidence either. These standard remedies of the conservative right and social democratic left are increasingly viewed by citizens as weak tea at best and cynical distraction at worst, relative to the scale of the challenge posed by the hollowing out of the middle class in advanced economies, increased marginalization of the poor in many developing countries, and growing disruption from automation and climate change. The longer that political leaders persist with these policies, the more they risk appearing complacent and ineffectual relative to the depth of change most people sense is required to deal with the disruption and dislocation that has already occurred, let alone what is fast approaching—and the more they risk feeding a vicious cycle of social disaffection and political cynicism and polarization.
Liberal economics’ policy immobility and political tin ear in the face of these challenges is rooted in a certain indoctrinated incomprehension. The implicit assumption that GDP growth eventually diffuses or “trickles down” into broad socioeconomic progress and security has never been properly recognized and interrogated. As a result, it remains an almost subliminal article of faith that continues to be baked into the thinking of economists and political and business leaders, who are conditioned by their training to believe that measures to expand GDP are the best and indeed only intellectually credible way to advance broad living standards—safety net programmes for the poorest notwithstanding. This cognitive reflex is reinforced not only in the use of GDP per capita as the standard measure of a country’s level of economic development but also by the relatively limited amount of theoretical and applied research on the relationship between economic growth and broad living standards as economics has developed as a social science over the past century and a half.
This blind spot of prevailing economic doctrine accounts for the widespread stasis of economic policy despite mounting social unease with the performance of economies in human terms—particularly with respect to social inclusion, environmental sustainability and human resilience and dignity. More than anything other factor, the trickle-down mental model of progress implicit in modern economics is responsible for the deer-caught-in-the-headlights political character of contemporary liberal governance, whether in its social democratic or conservative forms. It is increasingly out of step with the lived human experience and changing political attitudes of a growing cross-section of society as technological, environmental and demographic change (and geopolitical tumult) reorders the economic landscape.
The failure of modern economics to properly take account of the human implications of rapid and disruptive economic change has been roiling politics around the globe in recent years, creating an opening for demagogic populists to gain ground. It has done much to create the parched electoral landscape in which isolated wildfires of extremism have expanded into major infernos of social unrest and political instability, including in some countries that are traditional bulwarks of liberalism. Popular dissatisfaction with the way that socioeconomic opportunity and outcomes are being stewarded is providing the accumulated underbrush of kindling for these fires, making the job of political arsonists that much easier.
To be certain, the heated controversies over identity and immigration in many countries are not primarily a function of political economy. But, as Karl Polanyi famously observed when analysing the conditions that gave rise to fascism in Europe in the 1930s, such tensions are often fuelled by adverse economic conditions that reflect a failure of economic theory to reconcile high principle with the lived experience of people. While some actors appear to be working for various reasons to connect these blazes and whip them into a global political conflagration that would consume the liberal international order as we know it, the first step in extinguishing or at least controlling them is for friends of the liberal tradition and other users of its tools to recognize that the underlying hazard can be found closer to home—in the faulty wiring within our own mental model of economic growth and development.
Not since the Bolshevik Revolution and Great Depression has liberalism faced such an existential social and political threat. During that period in the early twentieth century, the academic and policy establishments struggled to understand and overcome the blind spots in the economic doctrine of the day that were preventing an adequate response to those two grave threats to capitalist democracies. The resulting course correction in political economy ultimately included a veritable revolution in monetary and fiscal policy; the creation of the so-called “welfare state”; and major new regulation of financial and labour markets, including the establishment of the International Labour Organization (ILO).
The ILO’s 1919 Constitution and 1944 Philadelphia Declaration annex articulated a tripartite (business–labour–government) consensus behind a new way of combining market economics with broad social progress and justice. In effect, these remarkable multilateral accords, which pre-dated the birth of the United Nations system and Bretton Woods institutions, articulated a universal baseline social contract in which working people were to be protected from being treated as mere commodities by committing employers to respect certain legally enforceable worker rights, governments to provide certain minimum social protections, and all three stakeholders to engage in ongoing “social dialogue” aimed at surfacing and resolving differences in good faith (i.e., without resorting to violent political confrontation).
The combined effect of these domestic and international institutional reforms was to change many of the basic rules and relationships within economies, to reset their “growth model” and social contract. This course correction contributed to several decades of robust economic progress in which national income and household living standards progressed in tandem throughout much of the industrializing world. Liberal economic governance requires a similar restructuring of rules and relationships to reset the growth model and social contract of our own day. That is the stark message being sent by the electorate’s vanishing confidence in the political and economic establishment in many countries.
A core thesis of this book is that the root of the increasingly serious crisis facing democratic capitalism can be located in a fundamental distortion in the way its canon of economic principles and tools have evolved since the eighteenth and nineteenth centuries, and especially in the way they have been applied over the past several decades. The key to reviving liberalism’s fortunes in the twenty-first century—including its noble project of promoting mutually reinforcing gains in living standards within and among nations in an open international economic system anchored in the rule of law and universal human rights—is to reconstitute its political economy, the way it conceptualizes and pursues economic progress. Absent such fundamental reform, its domestic and international political prospects are likely to continue to deteriorate. Its leaders and elites are likely to continue to give the impression of rearranging the proverbial chairs on the deck of a governance model sinking under the weight of its inability to adapt to the profound economic, social and environmental transformations of a new era.
The book does not aim to add to the considerable literature describing or measuring this challenge. Rather, it seeks to locate more precisely the doctrinal cul-de-sac within liberal economics that has been preventing an adequate response. It then attempts to construct a revised theoretical model and corresponding policy framework that would enable countries to achieve a better balance between the quantity and social quality of growth, in particular with respect to the key dimensions of inclusion, sustainability and resilience.
The book is organized as follows. Chapter 2 summarizes the historical track record of liberal economics with respect to inclusion, sustainability and resilience. The seriousness and persistence of its shortcomings in these respects suggest a structural problem in the model—a possible constitutional flaw in liberal economic doctrine. Chapter 3 takes up this question, examining the extent to which current practice varies from the original framework and underlying assumptions of liberal political economy’s eighteenth- and nineteenth-century intellectual pioneers. I find that the prevailing development model, by focusing so tightly on generating growth in national income—what Adam Smith called the “wealth of nations”—is out of sync with the mental model that Smith and other founders of liberal economics had of economic progress. Smith and two of the nineteenth century’s most influential theorists and codifiers of what was then called “political economy”, John Stuart Mill and Alfred Marshall, were moral philosophers before they were economists, literally and figuratively. They were quite explicit that markets alone could not deliver broad-based and lasting improvement in the material well-being of societies. Enabling policies and institutions were also needed in a wide variety of policy domains, which is to say that a robust social contract was every bit as essential as markets.
Their thinking in this regard was prescient. Increasing national income through a more efficient mechanism of resource allocation was precisely what was needed at the dawn of the industrial age, following a millennium of minimal productivity growth and wealth accumulation in poor, agrarian and feudal societies. But modern economic science, and particularly its late twentieth-century neoliberal variant, extrapolated these insights to near theocratic status, creating an intellectually consistent, mathematically rigorous construct with a growing real-world blind spot.
Particularly in high- and middle-income countries, the primary challenge today is not so much to boost the overall level of national wealth from abjectly low levels as it is to broaden the base of the growth process in order to expand its manifold benefits to the population as a whole and in so doing to make it more sustainable. If the planned-economy socialist experiment of the twentieth century failed because of its excessive focus on equity and control to the detriment of allocative efficiency and dynamism, the ongoing experiment in neoliberal capitalism is now staring its own political failure in the face for the opposite reason—an unbalanced focus on efficiency and aggregate wealth creation over the breadth of their payoff to society in the form of broad-based progress in living standards.
Chapter 3 probes the source of this blind spot and finds convincing evidence that it is not a congenital flaw; it cannot be attributed to the original principles of liberal policy economy. If there is an original sin, it is not in the thinking of the seminal political economists of the eighteenth and nineteenth centuries but rather in the highly context-specific interplay of circumstance, available tools and ideological overshoot as economics evolved into a more rigorous social science over the course of the twentieth century. The contemporary shortcomings of liberal economics are largely within our power to correct if we return to first principles and unlearn some of the reflexes and behavioural tics that have accumulated over the past century.
To this end, in Chap. 4, I present an alternative theoretical construct—or mental model—of growth and development which formally internalizes the role of enabling institutions related to inclusion, sustainability and resilience. It does so by defining the key channels by which gains in living standards propagate at the household level in an economy and modelling these as a system (a “function” in economics parlance). I argue that this “aggregate distribution function” is the de facto underlying income distribution system, or living standards diffusion mechanism, of modern economies, and that it deserves at least as much policy emphasis and investment as the factors of production in the aggregate production function. To support the operationalization of this reformulated growth model, I map the extensive ecosystem of policy domains and institutional features that correspond to the function’s five “factors of distribution” and suggest policy principles and tools to assist in the development of a strategy to activate them more fully.
Chapter 5 considers the implications for domestic economic policy of this rebalanced growth and development model, with its explicit dual focus on strengthening the median living standards as much as the aggregate wealth, or GDP, of nations. For each of the areas of policy and institutional strength, identified in Chap. 4, that help to diffuse gains in household living standards, I provide examples of good policy practice and present comparative data demonstrating the wide range of performance among peer groups of countries. These data serve to illustrate the considerable unexploited policy space that countries have at every level of economic development to improve their performance on one or another aspect of median living standards—to narrow what I call their “welfare gap” through a process of systematic and sustained institutional deepening that can often also help to reduce their output gap, that is, to boost economic growth, given the importance of many of these institutional features for labour productivity and aggregate demand.
Chapter 6 applies this more human-centred, living-standards-oriented approach to economics to international economic cooperation and governance. Over the years, many have called for a new Bretton Woods conference to renew the multilateral system and improve the coherence of its economic, social and environmental dimensions. But these appeals have never amounted to much, in part because they have lacked an organizing principle—a new or substantially revised policy model upon which to build a renovated institutional edifice. I argue that the reformulated growth and development model and accompanying policy framework and principles articulated in these pages provide such a compass. I propose a corresponding set of priority reforms of international macroeconomic coordination, the international financial architecture and international trade and technology governance. These proposals are ambitious relative to the incrementalism of recent years, but I demonstrate that they are entirely feasible in both financial and political terms; they would simply activate much more fully the existing capital and capabilities, and in many cases stated intentions and current initiatives, of the corresponding international organizations.
Chapter 7 concludes with a reflection on the potential implications of this fundamental critique and reformulation of modern economics for the legacy of the most influential economist of the twentieth century, John Maynard Keynes, as well as the liberal tradition’s political prospects in the twenty-first century. With its sharp focus on household living standards, human-centred economics is kitchen-table economics. It is fundamentally a strategy to invest in people—their employment opportunity, disposable income and purchasing power, and economic, environmental and social security. These matters are of tangible relevance to people of all demographics and political philosophies. Addressing them in a more direct and systematic manner would add a reinforcing structural dimension to Keynes’s macroeconomic approach to charting a more viable “Middle Way” between laissez-faire capitalism and state-centric socialism. It would also provide the basis for a more socially just and thus politically durable transition to the major climate action required by Paris agreement.
It would constitute a growth and opportunity strategy as well, a means of increasing economic growth by broadening its base, investing in its fundamentals and thereby strengthening its resilience. Growth has been lagging or outright lacking in most advanced and an increasing number of developing economies, and this has contributed to a vast underutilization of resources and loss of human potential, as manifested in high rates of youth unemployment and widespread underemployment and informal and insecure work. Investing more in people through tangible improvements in their household purchasing power, financial security, social protection, skills and access to decent work would strengthen aggregate demand, worker productivity and investor and consumer confidence—Keynes’s central preoccupation. These are the fundamental determinants of economic growth. By contrast, the standard trickle-down growth and development model has focused on improving conditions for capital investment through efficiency-enhancing supply-side reforms or boosting consumption through the periodic administration of fiscal and monetary stimulus—strategies that are well beyond the point of diminishing returns in many countries following decades of deregulation and privatization and years of extraordinary stimulus to combat the effects of the recent crises.
In sum, by establishing median progress in living standards as an explicit rather than residual consideration of economic theory, policy and measurement, the human-centred approach to economics suggested in these pages creates the prospect of capturing greater synergies—a stronger positive feedback loop—between production and distribution, markets and institutions, and efficiency and equity, that is to say, between growth and inclusion, sustainability and resilience. Chapter 2 begins with an examination of the historical track record of liberal economics in this regard.
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