My Wednesday post on the term ‘rational’ has brought forward some discussion of the term ‘economic rationalism’, which is now most commonly used in a pejorative . One commentator voiced the widely held assumption that the term was coined by Michael Pusey. In reality, the term was used, mostly positively for about 20 years before Pusey wrote Economic Rationalism. And although the term evolved gradually, the person who did most to popularise it was Gough Whitlam. The history of this phrase tells us a lot about the evolution of the economic policy debate in Australia. Read on for a piece I wrote in 1997, describing this history.
Although used much earlier by sociologists and social historians, the term ‘economic rationalism’ first entered the Australian lexicon in the 1970s. When the Whitlam government came to power, related formations such as ‘economically rational’ were used to describe the arguments of the group in the Labor Party, including Whitlam himself, who sought reductions in protective tariffs and agricultural price support schemes. By implication, opposing claims were regarded economically irrational. A little later, the term ‘economic rationalists’ was used to describe the supporters of free trade within the Labor government. This was a first step on the path by which the term radically changed its meaning.
Whatever the origin of the term, it has evolved a great deal since the 1970s. ‘Economic rationalism’ then referred to policy formulation on the basis of reasoned analysis, as opposed to tradition, emotion and self-interest. With the exception of support for free trade, there was no presumption in favour of particular policy positions. The views of the first generation of economic rationalists were generally in the economic mainstream of the period — Keynesian in macro terms and supportive of the ‘mixed economy’ in micro terms.
During the period of the Fraser and Hawke governments, both the intellectual character and the theoretical and policy content of economic rationalism changed. The critical and sceptical thinking that characterised the first phase of economic rationalism was gradually replaced by a dogmatic, indeed, quasi-religious, faith in market forces and the private sector. More and more, economic analysis was based on deductions from supposedly self-evident truths, which were effectively immune from any form of empirical testing. Many of the beliefs that are now central to ‘economic rationalism’ would have been regarded as irrational prejudices by the first generation of economic rationalists.
By the 1980s, economic rationalists had largely adopted the microeconomic views of the Chicago school, rejecting ideas of market failure in favour of the belief that the simple neoclassical model of perfect competition was a good description of the economy, or would be in the absence of undesirable government intervention. A variety of arguments were used to show that most market failures were unimportant or self-correcting. At the same time, the public choice theory of politics was used to introduce the idea of ‘government failure’. It was argued that, because of the systematic distortion of the policy process by interest groups, the costs of government intervention were greater than the costs of the market imperfections that government policies were supposed to remedy.
The evolution of economic rationalist attitudes towards the public sector followed a similar path. Mainstream economics provides a range of arguments for and against government intervention in particular cases. Consistently arguing against government intervention, economic rationalists came to rely on the view, naturally popular in the business sector, that private enterprise is inherently superior to government action. This view was reinforced in the 1980s by the perceived success of the ‘Thatcher revolution’ in the United Kingdom, and by the apparent dynamism of private sector entrepreneurs like Bond and Skase.
Nevertheless, the ambiguity surrounding the term ‘economic rationalism’ persisted. A survey of academic economists (Anderson and Harris 1996) revealed general agreement concerning the set of policies that constituted the program of ‘economic rationalism’. However, while those who identified themselves as opponents of economic rationalism agreed that economic rationalism involved strict opposition to government intervention and a belief in the inherent superiority of private enterprise, there was disagreement among those who regarded themselves as economic rationalists. Some ‘hard-line hawks’ agreed with the view that economic rationalism implied support for laissez-faire, but others adhered to the older definition, claiming that economic rationalism was nothing more than the application of mainstream economics to policy issues.
These ambiguities were exploited by some defenders of economic rationalism, such as James, Jones and Norton (1993), when their policy program came under attack during the 1989-90 recession. When responding to critics such as Pusey (1991), Toohey (1994) and Langmore and Quiggin (1994), they claimed that economic rationalism merely means policy formulation based on rational economic analysis, which, presumably, no-one could disagree with. The rest of the time, they assumed that economic rationalism implies support for radical free-market reform.
The style of argument adopted by economic rationalists is well illustrated by Parkin, who says:
Achieving a redistribution of income and wealth by taxing incomes is inferior to taxing expenditures while taxing capital income is the least efficient of all. Progressive taxes are also highly inefficient. These are not statements of opinion. They are fact.
I assume that what Parkin means is that these propositions may be derived as logical deductions from an economic model based on the assumption that individuals, with no inherited wealth and facing perfect labour and capital markets, rationally optimise their lifetime work and consumption patterns. Even with these assumptions, I do not think Parkin’s claim that the optimal tax schedule is linear rather than progressive is justified. It is a matter of fact that the assumptions underlying the life-cycle model are not exactly satisfied in reality. Contrary to Parkin’s assertion, it is a matter of opinion whether the differences between reality and the model are sufficient to invalidate the policy conclusions derived from the model. But the use of dogmatic assertion, and the claim that anyone who holds contrary views is not a real economist, are standard features of economic rationalist rhetoric.
Despite these rhetorical manoeuvres, ‘economic rationalism’ became a primarily pejorative term in the 1990s. In part, this change arose because economic rationalists, who now dominated the main economic policy-making institutions, found it less necessary to justify their views in public debate, and therefore less useful to identify themselves as members of a school of thought. The shift also reflected a substantive change in the policy debate as it became evident that radical free-market reforms had failed to deliver the promised benefits. (The jury is still out on whether any net benefits have been realised. On the whole the evidence suggests that microeconomic reform has yielded modest benefits in Australia, but that the unconstrained dominance of economic rationalism in New Zealand has led to consistently poor outcomes.)
In philosophical terms, the opposite of rationalism is not irrationalism but empiricism, that is, a willingness to form beliefs on the basis of experience rather than from a priori deduction. Empirical evidence never yields the dogmatic certainty that accompanies logical deduction. I interpret the economic experience of the last two centuries to show that an unregulated market economy is inherently unstable and that a mixed economy, with an appropriate allocation of productive activity between the public and private sectors yields outcomes superior to those generated by either of the polar alternatives – laissez-faire capitalism and comprehensive socialism. Others, particularly those who focus on the strong performance of the US economy the last decade, have drawn conclusions more favourable to the market economy.
Empiricism is consistent with an approach to policy-making based on willingness to adjust the role of the public sector in the light of new experience and of innovations in technology and policy design. Such an approach is more rational than economic rationalism.