It has been widely suggested and supposed that the abolition of exchange controls – one of the great episodes of financial deregulation in the United Kingdom since the 1970s – was the result of lobbying by the City of London. In this post for Fools’ Gold, Jack Copley of Warwick University explores the history, and finds a rather different story, focusing particularly on the issue of ‘competitiveness’ as it applies to the exchange rate.
What role did the ‘competitiveness agenda’ play in the Thatcher government’s deregulation of finance?
The case of exchange controls
By Jack Copley, Warwick University
Fools’ Gold has continued to expose the nefarious power of the City of London in British policymaking. As the biggest sector of the British economy, it is able to exercise undue influence over the government in order to secure preferential treatment. The notion that the City must remain globally competitive, and that ordinary people should be concerned about ensuring this, is a key part of the ‘competitiveness agenda’ in the UK.
Margaret Thatcher is the British politician most commonly associated with the City. Under her administration, a number of key financial deregulations took place, including exchange control abolition (1979), the Big Bang (1986), and the Building Societies Act (1986). Experts generally points to two explanations for the Thatcher government’s deregulatory agenda: 1) the City’s lobbying power; and 2) Thatcher’s ideological desire to promote the interests of the City over those of industry. This was particularly the case with exchange control abolition, which is widely perceived to have been a case of Thatcher giving a direct subsidy to financial elites and justifying it with rhetoric about national competitiveness.
The German-American economist Friedrich List never once mentioned competitiveness directly by name, but he nonetheless remains an important figure in the pre-history of the Competitiveness Agenda, a modern body of thought that, put crudely, says that countries need to shower capital on capital and the owners of capital, for fear that they’ll flee to more hospitable jurisdictions. It is, in part, a theory about how nations ‘compete.’
List is not a famous economist from history, and this blog judges him harshly. But this is not to say that he should be ignored: one cannot present a comprehensive historical account of the agenda without at least some discussion of List’s National System of Political Economy. It was he who first made the case in the 1840s for collective national sacrifice in the interests of stronger future macroeconomic performance. Choose carefully the sectors in which you might expect to prosper at other countries’ expense, he said, and then channel all available resources into those sectors. No other social objectives could be allowed to interfere with this one overriding priority, which is why List felt able to advocate the political privileging of national economic champions.
This latest post for Fools’ Gold by Matthew Watson reviews List’s arguments, but also shows why they have never been treated as good economics.
There are many instances in the history of economic thought where economists did not use what today has become the concept of ‘national competitiveness’ but nonetheless wrote about things that look eerily familiar when viewed through the lens of the modern-day Competitiveness Agenda. Veblen’s 1904 Theory of Business Enterprise contains many important passages of this nature. Business leaders, he noted, had become remarkably successful at presenting themselves as the selfless foot soldiers in a national struggle for international economic pre-eminence. Yet for Veblen this was all a carefully constructed smokescreen. They could hardly be seen as guardians of the national interest, he argued, because they enacted significant damage on the economy’s social provisioning capacity in the self-serving desire to protect the social inequalities from which they benefited so handsomely. This latest post for Fools’ Gold by Matthew Watson captures the essence of Veblen’s original argument, while drawing out its implications for understanding the modern-day Competitiveness Agenda.
The Nobel Prize winning economist George Stigler wrote a famous intellectual history of the concept of perfect competition in the late 1950s (see Box 1, below). The article has subsequently attained canonical status among orthodox economists. It does not mention the contemporary notion of competitiveness once, but as Matthew Watson shows in the latest post for the Fools’ Gold history files, it is full of important implications for those who wish to question the intellectual authority of the modern-day competitiveness agenda.
In particular, Stigler is forced to admit that there is no purely economic basis for supporting the idea of a perfectly competitive economy. His argument that there are still good grounds for keeping up this pretence boil down to straightforwardly political beliefs for wanting to keep the government out of economic life. Despite what will be shown to be their important differences, this is one thing that the theory of perfect competition and the modern-day competitiveness agenda have in common. Both are typically dressed in apparently economic clothes, but each in its own way must be understood as a purely political intervention into public affairs.
Paul Samuelson and the Provision of Collective Consumption Goods: A Rejection of Competitiveness Logic
Paul Samuelson pioneered the mathematical models of maximisation that today form a central part of the economics of competitiveness. It is significant, then, that the pioneer himself deployed his method of difference equations to come to a conclusion that is wholly opposed to modern-day competitiveness mantra. This post by Matthew Watson brings Samuelson’s argument to a wider audience as the latest instalment in our series tracing the intellectual underpinnings of contemporary competitiveness discourse. It reviews his defence of collective provision of the public goods that enhance individual welfare and his view that the funding of public goods should be protected from race-to-the-bottom dynamics.
David Ricardo’s Theory of Comparative Advantage: Exploring the Hidden Historical Underside of Modern-Day Competitiveness Discourse
David Ricardo’s status as the first really famous economist of the nineteenth century rests on two capacities: his ability to think in pure economic abstractions and his ability to harness economic theory to a liberal political worldview. They came together most famously in his theory of comparative advantage, through which countries are encouraged to specialise in producing the goods in which their workers are relatively most efficient. Despite being two hundred years old, Ricardo’s theory is still the mainstay of the orthodox economics justification of free trade and, at one stage removed, of modern-day competitiveness discourse too. This post by Matthew Watson looks behind the façade of the numbers that Ricardo used to illustrate his theory of comparative advantage, to show that they were anything but an innocent account of essential economic relationships. It therefore helps to place modern-day competitiveness discourse in a far from flattering intellectual light.
Adam Smith was an arch-critic of the regime-hopping strategies of the exclusive stockholding corporations, the forerunners of today’s multinational corporations. The British East India Company, granted a Royal Charter, was supposed to be acting on behalf of the sovereign to meet the country’s commercial objectives. The free hand given to the Company would presumably be couched, in modern parlance, as a ‘competitive’ strategy for Britain.
This post by Matthew Watson, showing how rude Smith was about these corporations’ strategies, is the latest in our series exploring the intellectual history of the modern ways people talk about the ‘competitiveness’ of national economies.
The ways people talk about the ‘competitiveness’ of countries so obviously relates to the economy that they must have their roots in economic theory – wouldn’t you think?
In the first of a series of pieces exploring the history of competitiveness thinking, Matthew Watson suggests that things are not quite so simple.
This article will be stored permanently in our new history section.
Slot machine man and the origins of the “Competitiveness” discourse
By Matthew Watson
In one telling, competitiveness discourse is a way of talking about the economy without the need to get too close and personal with the technicalities of economic theory. After all, however often economists-in-the-wild are invited onto our television screens to speak about how competitive the economy has become today, no self-respecting academic economist is likely to grubby themselves with a concept so utterly lacking in analytical rigour.
In an alternative telling, however, competitiveness discourse would be a way of talking about the economy which has been embedded in economic theory for as long as there has been a modern discipline of economics. All that stuff in Adam Smith with which people are most familiar – the ‘invisible hand’ metaphor and the passage about the self-interest of ‘the butcher, the brewer and the baker’ – seems to consistently invoke thoughts of competitiveness.
So, which is it to be? Is competitiveness an intellectual reference point that academic economists have conspicuously avoided — or one that they have always held in a warm embrace? Both cannot be correct at the same time.
My answer, as is so often the case when faced with a stark choice, is that neither perception is right.
There is evidence, it is true, of the use of the word ‘competition’ in The Wealth of Nations. For the Smith anoraks out there, some combination of it or its derivatives appears 155 times. However, it requires a strategic reading into Smith’s work of current concerns about competitiveness to make this mean anything more than the mundane task of ensuring that economic agents position themselves sustainably relative to market prices. It is about organising production so that selling goods at the ‘natural price,’ where all productive inputs are reasonably rewarded, does not mean having to sell at a loss.
“The results of bargaining away regulatory oversight of corporate activity certainly helps to enhance the utility that companies can extract from their productive activities. If the single goal of managing and administering modern market institutions is to embed corporate interests, then this seems to be the way ahead.
But if the goal is to make the economy react to a rather wider political agenda, then we need to explore and understand the particular intellectual origins of competitiveness discourse.”
Nowhere was competitiveness understood as a logic of behaviour where competent economic agents try to undercut each other to load the market environment to their own advantage. In short, this was a game that companies played solely against the structure of natural prices, not against one another. What is more, while the structure of natural prices was a meaningful baseline for companies because it told them what they needed to do to cover their production costs, the same could not be said of countries.
It required significant evolution in the underlying system of economic thought before something could emerge that is more familiar from today’s perspective. In particular, it needed successive reincarnations of a creature called homo economicus: the legendary figure of ‘economic man’ who has been used to populate economic theory. The most important developments in this regard were brought to life in the 1920s by Frank Knight, the Chicago economist who was at the forefront of the American turn towards neoclassicism.
Neoclassical economic theory always made strange demands on individual economic agents, and Knight made them stranger still. His most well known book Risk, Uncertainty, and Profit requires ‘economic man’ to live in a highly idealised mathematical world where behaviour necessarily traces out the result of a geometric equation. To do this, homo economicus must possess boundless knowledge, and infinite rationality to act on that knowledge. (This, by the way, robbed this agent of genuine intelligence: economic behaviour was reduced to automatic responses to external stimuli, and no longer needed to be thought through.)
Acknowledging this state of affairs, Knight later characterised ‘economic man’ as treating “other human beings as if they were slot machines”. This ‘slot machine man’ was the first homo economicus in the history of economic thought to have the modern meaning of competitiveness inscribed into it as a behavioural instinct. Economic man thus became the ultimate bargaining agent, able to wheel and deal in an instinctive manner to ensure that everyone automatically sells to him at the lowest possible price and buys from him at the highest possible price. By creating it this way, Knight also removed its social relevance drawn from the game that might be played against the structure of natural prices. Instead, economic theory became all about mapping the logical implications of allowing purely utility-maximising agents to compete against one another for their own ends.
Knight did not pretend that the characteristics of homo economicus could ever be captured by an actual person. But this was not the point he was trying to illustrate. This was, above all, a thought experiment: homo economicus designed specifically to act out the utopia of neoclassical economic theory. It was a caricature – but a caricature with rich political implications because it was a symbol of perfection. Slot machine man represented the highest stage of evolution of economic man within the peculiar world of neoclassical economic theory. If you wish for the sake of analytical simplicity to restrict the objective of everyday life to nothing more than chasing utility, then this is as far as it is possible to take homo economicus.
Modern competitiveness discourse – including in relation to the way that whole nations compete with each other – has its intellectual origins in exactly the same thought experiment. So it is relevant to ask whether it remains fundamentally trapped within it. The results of bargaining away regulatory oversight of corporate activity certainly helps to enhance the utility that companies can extract from their productive activities. If the single goal of managing and administering modern market institutions is to embed corporate interests, then this seems to be the way ahead. But if the goal is to make the economy react to a rather wider political agenda, then we need to explore and understand the particular intellectual origins of competitiveness discourse.
Clearly this is not just of academic interest. Today, competitiveness discourse is so ingrained into the management and administration of modern market institutions that it has become increasingly difficult to think of the latter other than through the lens of the former. So it has become a politically debilitating concept. Showing that it was not always this way demonstrates that it does not have to be this way forever, and that political alternatives are possible. There is no formal logic of competitiveness that necessarily has to be lodged at the heart of economic theory, as Knight himself made abundantly clear, when he admitted that his slot machine man was merely a convenient modelling device. Modern economics had evolved quite happily for 150 years from Smith’s Wealth of Nations to Knight’s Risk, Uncertainty, and Profit blissfully unaware of any supposedly necessary attachment to modern meanings of competitiveness.
Only in the subsequent century did the two things become forged so closely together – leaving the contemporary political imagination all the poorer for it.
Matthew Watson is Professor of Political Economy in the Department of Politics and International Studies at the University of Warwick and a Professorial Fellow at the UK’s Economic and Social Research Council.
In 2011 the U.S. economist Paul Krugman wrote an article in the New York Times in which he stated:
“The idea that broader economic performance is about being better than other countries at something or other — that a
companycountry is like a corporation –is just wrong. I wrote about this at length a long time ago, and everything I said then still holds true.*”
Krugman was referring, most notably, to “Competitiveness: a Dangerous Obsession,” a long essay he wrote in 1994 for the U.S. publication Foreign Affairs. A lesser-known essay of his, Pop Internationalism, contains the memorable phase:
“If we can teach undergrads to wince when they hear someone talk about ‘competitiveness,’ we will have done our nation a great service.”
It’s worth noting that the competitiveness discourse in those days was quite heavily focused on trade: the competitiveness agenda seems to have expanded its reach substantially since then to include tax, labour provisions, welfare, financial regulation, and many other areas of economic life.
Paul Krugman on ‘Competitiveness.’
Bad analogies have abounded in the years since the 2008 crisis. Two of the most pernicious have been that national economies are essentially like households or like businesses. While the first comparison has been roundly attacked, the second has been a bit harder to put to bed.
However, in his 1994 article for Foreign Affairs, Paul Krugman took this exact same argument head on. He not only challenged the idea that nations have to compete with one another like businesses, but went as far as to argue that “competitiveness is a meaningless word when applied to national economies”. I’ll give an introduction to the main arguments of his piece, and then propose some questions that are raised of its thesis by unfolding global events.
- Competition is about trade – which is of limited importance.
When politicians talk about national economic competitiveness, (like UK Prime Minister David Cameron and his #globalrace), they often mean exports. Krugman accepts this premise and then sets about showing why we needn’t be too concerned about it.
“In an economy with very little international trade, the growth in living standards… would be determined almost entirely by domestic factors, primarily the rate of productivity growth… ‘[C]ompetitiveness’ would turn out to be a funny way of saying ‘productivity’ and would have nothing to do with international competition.”
Krugman focuses on the U.S., which has a large domestic economy relative to its external trade. For economies with sizeable domestic markets, export competitiveness plays a far smaller role in determining national prosperity than politicians would have us believe. Issues of domestic economic strategy, such as productivity, are more important.
Furthermore, trade surpluses are not always a sign of health. Krugman gives the example of Mexico in the 1980s, a country forced to ensure large surpluses “to pay the interest on its foreign debt since international investors refused to lend it any more money”; Mexico then began to run large trade deficits after 1990 as foreign investors recovered confidence and poured in new funds. To find modern parallels one only has to look at the UK, where the current account has been deep in deficit for nearly all of the last 30 years without a commensurate stagnation in living standards. The case of Japan today also springs to mind, as their notorious ‘Lost Decades’ accompanied a huge surplus.
Ultimately, competition of the #globalrace variety is generally not as important as it’s made out to be, particularly for larger economies. Countries don’t need to compete like companies do – they are more self-reliant and they benefit much more from the success of others.
- The competitiveness myth is sexy.
Despite relying on simplifications that don’t hold much water, the idea of the nation as a business is compelling. It evokes imagery not just from the business world, but also from sports, with the whole country pulling together as a team in order to assert itself in a fierce global environment.
Krugman details numerous examples of how competitiveness jargon was used to sell unpopular policies. But even today governments around the world routinely justify tax breaks for the rich, financial deregulation, attacks on labour unions and public service cuts all in the name of gaining an advantage over other national economies.
- It’s a dangerous myth.
Krugman argues that not only is the obsession with national competitiveness fundamentally misguided, but it is also harmful. If the principle of absolute competitiveness is internalised too much, it can lead to trade wars and protectionism when political leaders feel that their countries are simply unable to compete on an even playing field. Indeed, “a government wedded to the ideology of competitiveness is as unlikely to make good economic policy as a government committed to creationism is to make good science policy”.
Another very real danger that Krugman doesn’t mention is the xenophobic and racist sentiments that can be roused when the rhetoric of national competition is drummed into people’s heads. In Britain, UKIP is the most proficient at this particular manoeuvre – but it has been a phenomenon associated with all the major British parties at one time or another.
Some things to ponder
Last week, UK Chancellor Osborne had the tough task of standing up in the House of Commons and trying to say something positive about the British economy. As economics blogger Michael Roberts points out, GDP growth, productivity, inflation and income growth are all below what was expected by the 2010 OBR forecast. However, with a sprinkle of “promote competition”, a dash of “competitive taxes”, and the slightly embarrassing characterisation of Britain as the “Comeback Country”, Osborne managed to shield the underlying economic weaknesses from view. In other words, Krugman’s point about the political salience of the competitiveness narrative is just as relevant today.
Yet, Krugman’s claim that Western countries are not “to any important degree in economic competition with each other”, is perhaps a little harder to digest in the current context. Amongst the most pressing issues now is the crisis of the peripheral Eurozone countries, especially Greece. One of the central causes of this crisis is Germany’s massive trade surplus and the consequent deficits of the “PIIGS”. Unable to compete with Germany’s harsh suppression of its own workers’ wage growth, many of these peripheral countries came to rely instead on cheap credit to fuel unsustainable public spending (Greece, Portugal) or housing bubbles (Ireland, Spain). Can we really say that these countries did not find themselves under real pressure to compete on exports? Or, if Krugman’s analysis only applies to “leading nations” with large domestic markets, then must 133 million Europeans (the population of the PIIGS) just accept their fate?
Another confusing point in Krugman’s analysis is why competition is limited to global export markets. Even in an economy that is totally domestically-oriented, investors can sell their equity in a company and shift their money overseas if they think they can earn more profits. For example, investors may shift their funds from a US restaurant chain to a Brazilian one if it can offer higher returns. Individual firms are in competition with every other firm, not just those that share the same consumer markets.
Regardless, Krugman’s article is still a sharp and important provocation in a contemporary world in which lazy assumptions about national competitiveness are too often left unchallenged.
Further quotes from the 1994 article:
- “Countries are nothing at all like corporations . . . countries do not go out of business.”
- “The rhetoric of competitiveness — the view that, in the words of President Clinton, each nation is “like a big corporation competing in the global marketplace” — has become pervasive among opinion leaders throughout the world. People who believe themselves to be sophisticated about the subject take it for granted that the economic problem facing any modern nation is essentially one of competing on world markets.”
- “The idea that a country’s economic fortunes are largely determined by its success on world markets is a hypothesis, not a necessary truth; and as a practical, empirical matter, that hypothesis is flatly wrong.”
- “The growing obsession in most advanced nations with international competitiveness should be seen, not as a well-founded concern, but as a view held in the face of overwhelming contrary evidence. And yet it is clearly a view that people very much want to hold.”
- “The obsession with competitiveness is not only wrong but dangerous, skewing domestic policies and threatening the international economic system.”
- “Most people who use the term “competitiveness” do so without a second thought.”
- “Over and over again one finds books and articles on competitiveness that seem to the unwary reader to be full of convincing evidence but that strike anyone familiar with the data as strangely, almost eerily inept in their handling of the numbers.”
- “In each case, the growth rate of living standards essentially equals the growth rate of domestic productivity — not productivity relative to competitors, but simply domestic productivity.”