“The world has experienced an unprecedented set of shocks in a very short span of time,” said Joseph E. Stiglitz at the start of his lecture at #LINOecon. The problem of how to manage the economic aftermath of the pandemic quickly changed into how to manage current inflation, and protect low- and middle-income households from poverty. The dramatic increase in inflation, exacerbated by the war in Ukraine, has already pushed an estimated 71 million people into poverty in just three months since March 2022, as reported by the UNDP. The origins of these shocks are not just purely economic, but also political with economic implications.
Stiglitz explained that the prevailing macroeconomic models are flawed and are of no use in crises like these. The models assume equilibrium without any theory of how such equilibrium could be attained. Also, the theory of stochastic shocks is misguided; shocks are unpredictable events (exogenous) and are not created by the economic and political system. The lack of rational expectations and common knowledge generate fluctuations that can’t be offset by slow adjustment processes, such as wage and price setting.
According to Stiglitz, policy guidance, notably fiscal policy, is central to improving the performance of the economy. Better-designed automatic stabilisers, regulation of the financial sector, and well-designed fiscal policy to alleviate supply chain problems are just a handful of suggestions that could help solve the big problems of 2022.
Edmund S. Phelps introduced his lecture by outlining the theories of the German historical school of economics and the Austrian economist Joseph Schumpeter, that all innovations are commercial applications of scientific discoveries. Phelps builds the convincing argument that a wave of widespread innovation took place all over western Europe starting from the 1860s, and this wasn’t generated by scientists and the educated, but by “people of low education who were daring and original”, who wanted to find new methods of doing things, and who were also engaged in their work. “Every industry had workers who hit upon new ideas, and many people started new firms,” explained Phelps.
This dynamism set the stage for long-term prosperity in these countries, but “values are subject to change” and innovation greatly diminished by the 1970s, currently occupying only a small part of the economy.
Phelps told the audience that there are far too few solutions on how to galvanise innovation in modern society. But the cause of the slow growth is not just the lower rate of discoveries, but also the rise of corporatism, government control and “the obsession with material gains, income and wealth.” A good job is not only a salary, but has to be meaningful and provide an occasional sense of succeeding, “flourishing using one’s imagination.” Only that kind of engagement at work can drive innovation.
Stiglitz and Phelps expressed the need for better economic policies for the future, but Vernon L. Smith’s lecture took a different path, focusing on the works of the Scottish economist Adam Smith, who was born nearly three centuries ago, but whose theories are surprisingly relevant today. In his first classic work, “The Theory of Moral Sentiments”, Adam Smith recognised the difference between the origins of actions and their consequences, and this forms the backbone of social propriety, where “benefit means more and hurt means less of a good thing”. Adam Smith’s second magnum opus, “An Inquiry into the Nature and Causes of the Wealth of Nations”, established a theory of market price formation, which the future Neoclassical school failed to provide. As Vernon Smith noted, “Smith’s model predicts the patterns observed in the first market experiment 180 years later.”