Unemployment, underemployment, low wages and inflation are the major economic challenges of today's world

A different explanation of how the economy works

1. Greater Premise

The facts have proved that respect for economic freedom is fundamental to improving the living conditions of societies. But this respect for economic freedom is not enough because in the countries where it is applied there are also big problems such as unemployment, underemployment, low wages, inflation and deflation. It is thus proved that the orthodox free market model does not guarantee the full employment of workers or fair wages. In the United States, which is the world capitalist model society, the market is not in balance, there are millions of poor people, homeless people who sleep on the streets, millions of people absent from the health system because they cannot afford insurance, privatized higher education closes the door to millions of students, many companies keep their factories abroad to reduce costs which prevents the full utilization of the productive potential of that country, the minimum income is insufficient to meet the needs of workers and in a society in such conditions obviously the market can not be in balance. Something similar happens in part of Western Europe; The level of unemployment is high in Spain, Portugal, Italy, Greece and other countries; Pensions and general incomes of workers have been reduced and also the public health and education services; It is clear that in these countries the market is not in equilibrium either, although global indicators such as GDP can show positive signs.

2.  Objectives of the essay

In this paper I want to express the following:

A) That in the real world the economy is not a science because its laws are not always and unfailingly fulfilled; For example, a surplus supply of goods does not always bring as a consequence a reduction in the prices because the market may prefer to discard surplus production rather than reduce the price; Something similar happens with an increase in demand since economic agents may prefer to import rather than increase its production. In none of the above cases are the laws of the market obeyed. The fundamental requirement of science is the certainty and permanence of its postulates in time: for example, that heat expands bodies is a valid scientific truth now and always; But the economy cannot present absolute truths like those of the exact sciences because it is only theory that is sometimes fulfilled and sometimes it is not fulfilled in practice; The reason very simple:  because the economy depends on the most variable that exists in the world, human behavior.

B) The economy has tried to achieve some degree of accuracy with the incorporation of mathematics but has not really achieved. For example, if mathematical models of prediction were successful then major economic crises should not occur, but in reality this is not the case.

C) Perfect competition does not exist and on that premise was that economists founded the basic laws of economics. If perfect competition does not exist in practice then all the argumentation built on that basis is only theoretical.

D) In ​​the economic reality there are multiple markets with their own and different characteristics that hinder the existence of a general equilibrium, which is a balance of all markets simultaneously.

E) The desire to accumulate more wealth is the force that drives the owners of capital and to achieve wealth are able to do anything, as well recognized Adam Smith in his famous phrase in which he said that "a meeting of traders cannot come out anything other than a conspiracy to raise prices. "

F) No one can assure that the economic agents act in a 100% rational way influencing in that way in the market; Human egoism is contrary to rationality.

G) The equilibrium price promoted by supply and demand is a fiction because in the reality of all countries, from the most liberal to the least, there are multiple factors that impose costs and prices, including regulations such as legal interest rates, the minimum wage, taxes, import and export restrictions, maximum prices for some products and other legal restrictions, what economists call externalities, which are above the impact of supply and demand on prices.

(H) Unemployment, underemployment, miserable wages, inflation and speculation are the most common and important economic shocks that have always been present in history and constitute the main causes of the poverty of nations.

I) The Quantitative Theory of Money that attributes inflation to money abundance is only partially true.

J) Prices, when they go up, are not easy to get down. Entrepreneurs increase prices but struggle not to raise wages.

K) Economic indicators such as GDP do not reflect the true reality of the economy or the well-being of the population of the countries.

L) Economic policy defines the direction of the economy in all societies, including those in the free market; that means that in reality it is not the market but the governments that ultimately decides the entire economic process, from the forms of ownership to how much to pay taxes.

3.  Synthesis

From the eighteenth century until now, the first decades of the twenty-first century, orthodox economics has employed the idea of the invisible hand of the market as a determinant of equilibrium in the economy. This idea, expressed by Adam Smith in the eighteenth century, was accepted by the rest of the classical economists and then by the leading exponent of the marginalist economy, Marie-Espirit-Léon Walras (1834-1910), through his Theory of Equilibrium General of Supply and Demand, and by Alfred Marshall (1842-1924) the leading figure in neoclassical economics, which developed the Theory of Partial Equilibrium. Both theories have so far been considered by orthodox economics as the correct explanation of how the economy works.

4.  What is the Theory of General Equilibrium of Supply and Demand?

The general theory of the balance between supply and demand means that in a market of perfect competition in supply and demand there are no significant changes as the lack or abundance of goods and services because the market produces and consumes the quantities it needs and that if any alteration is generated, the same market corrects it through prices, increasing or decreasing them. Adam Smith (1723-1790), founder of classical economics, first exposed the essence of this idea in his book The Wealth of Nations, published in 1776, that is just 26 years after the beginning of the First Industrial Revolution. This fact is important because it reveals that Adam Smith knew only the first stage of the new form of industrial production and that his fundamental experience was based on the behavior of the agricultural and commercial society inaugurated in the Modern Age, from the discovery of America. Smith, therefore, did not thoroughly know the economic and social results of the new form of industrial production and that makes his theory cannot adequately explain the reality after him.

5.  Previous Developments

It should be noted, however, that a prior explanation of the balance between supply and demand in the economy was implicitly, not explicitly, given by the Physiocrats in the eighteenth century; In fact, Dr. Francoise Quesnay, the most important figure in Physiocracy, considered the first school of economic thought, first proposed, implicitly, the concept of equilibrium that would later be developed by classical economists. Quesnay, who was a physician, knew that any alteration in any part of the human body, that is, any imbalance, modify health as a whole and applied that same idea to the economic process, so he proposed to allow greater freedom to the economy without the intervention of political power. Quesnay and the Physiocrats thus responded to the mercantilist thesis, which had been established in Europe since the seventeenth century, which held that trade and precious metals were the cause of the wealth of nations, for which was necessary the intervention of the State in economy. Adam Smith, considered the founder of classical economics, continued the liberal idea of ​​the Physiocrats and synthesized it in his famous phrase "the invisible hand of the market" which he considers capable of ordering the whole economic process and, consequently, supply and demand.

6.  Supply, Demand, Money and Inflation

Since ancient times the effect of money on supply, demand and inflation has been known. In fact, history reveals that the Roman Empire suffered for a long time the inflationary problem and some authors attribute to that phenomenon one of the main causes of its fall. The Roman emperors at various times made changes in monetary policy by devaluing the metallic content of the coins and regulating some prices such as the price of wheat. But it was Emperor Diocletian (244-311) who adopted the broadest policy on the subject including numerous assets in regulation and establishing the death penalty for those who violated it. This fact highlights the seriousness of the problem at that historical moment.

The Middle Age was inaugurated with the fall of the Roman Empire in the year 476; it is considered the darkest period in history and was characterized by Theocentrism, a unique influence of God and the Catholic Church in all aspects of life. From this period there is very little evidence of important studies and among them it is worth mentioning the great philosophical and religious work of St. Thomas Aquinas (1225-1274), who condemned usury, unjust salary and unjust price; His most notable book is Summa Theological. Another important philosopher and priest of the Middle Age is Nicholas Oresme (1320-1382), considered the father of the monetary economy, who wrote the first treatise on the subject in his book Origin, nature and alterations of the coin (1358). Oresme criticized the devaluation of the currencies through the diminution of its content of gold and silver but maintaining its nominal value, which already had become custom in Europe.

The Modern Age, which begins with the discovery of America in 1492, opens the door to the development of thought and knowledge that had been truncated throughout the previous historical stage, the Middle Age.

With the Modern Age the Renaissance was inaugurated in Europe in all fields of knowledge and the first steps are taken for the development of the economy as a discipline of study, influenced in a special way by the discovery of America that brings to Europe immense amounts of gold and silver plundered by the conquerors. That fact gave rise to the first global economic conception, Mercantilism, a doctrine that favored foreign trade and which considered precious metals as the cause of the wealth of nations. The great wealth of gold and silver brought to Europe created a major monetary expansion which, in turn, generated significant inflation. In that new scenario is that the first theses of economics arise.

Martín de Azpilcueta (1492-1586), a Spanish philosopher and priest, is one of the first figures of the Modern Age to study economics, and he is credited with the first formulation of the Quantitative Theory of Money (1556), which raises the relationship between amount of money in circulation in an economy and the price level.

Jean Bodin (1530-1596) was a student of Martin Azpilcueta and continued his work on the Quantitative Theory of Money; Bodin published his thesis on monetary policy in 1568 and later his most important work, The Republic, in 1576.

In the seventeenth century, Juan de Mariana (1536-1624), Spanish priest, continued the same critical wave in his book Treatise on the alteration of the currency, a book that was banned and brought to jail its author.

Later, in the eighteenth century, David Hume (1711-1776) and then David Ricardo (1772-1823) in the 19th century formulated a more complete work on the subject. Ricardo following the Quantitative Theory of Money assured that the prices of goods increase or decrease depending on the amount of currency in circulation. This thesis was refuted by John Stuart Mill (1806-1873) who stated the opposite, that is, that changes in prices are what determine the increase or decrease of the amount of currency.

In the twentieth century, Irving Fisher (1867-1947) ventures into the subject and introduces the concept of the velocity of circulation of money to which he attributes the cause of the variation in prices.

In the twenties and thirties of the twentieth century the economy experienced a new reality: German hyperinflation and the Great Depression in the United States. The medicine prescribed by the orthodox economy, which considered that the invisible hand of the market would recover the balance, was not successful and was thus a new approach, the recovery program first undertaken in Germany (Weimar Republic) by the President of the Reichsbank Hjalmart Schacht (1877-1970) in the 1930s and then the New Deal policy for the economic recovery executed between 1933 and 1939 by the President of the United States, Franklin D. Roosevelt. In those years, in 1936, John Maynard Keynes's General Theory of Occupation, Interest, and Money (1883-1946) appeared which gave intellectual support for the new policy that promoted direct investment by the State to stimulate demand and end unemployment. The program was successful and applied from the thirties to the early seventies of the twentieth century. A few years earlier, in the 1960s, signs of inflation and monetary instability began to emerge, caused by Germany, which then began a process of strengthening its currency, attracting capital to that country, which affected the value of the dollar; in 1971 it was disassociated from the gold standard. This, coupled with the new taxes imposed on oil companies first by Libya and then by the rest of the oil countries caused inflationary pressures at world level that then peaked after 1974 as a result of the Arab oil embargo on States United States and the rest of the Western nations. In this scenario, the questioning arises to the Keynesian thesis that had not been able to avoid the new inflation. Milton Friedman (1912-2006) and the Chicago School take the initiative and propose the resurgence of the neoclassical thesis and the Quantitative Theory of Money to explain the inflationary phenomenon of that time. This thesis is adopted by the Prime Minister of Great Britain, Margaret Thatcher, the President of the United States, Ronald Reagan and international financial organizations, imposing Neoliberalism, whose main idea was the non-intervention of the State in the economy and the austerity of public finances to achieve balance. The consequence of this policy was the privatization of numerous companies and public services in the countries where Neoliberalism was applied, the increase of the debt of the developing countries that had crisis in the year 1982 when many countries could not pay their commitments, loss of sovereignty because of the privatization of its main economic activities and the increase of poverty, due to the increase of interest rates and the elimination of labor protection policies, among other factors. The objective of Neoliberalism was to leave to the invisible hand of the market the restoration of balance in the economy and the fight against inflation. Neoliberal politics was fully in force in the 1980s, 1990s and the beginning of the 21st century but was unsuccessful. The crisis reappeared with great intensity in 2008, with the collapse of the main financial institutions of the United States and some of Europe, which again caused the intervention of the State to avoid the collapse of the economy of those countries, due to the magnitude of the debts of private financial institutions. The bankers received the money given by the governments to pay the debts to the savers but many did not and they were left with the public money.

7. Does the theory of the general equilibrium of supply and demand really reflect the truth of the market?

To speak of general equilibrium of supply and demand would have to take into account the balance in each of the existing markets in an economy and that is very difficult in practice. The equilibrium is the maximum satisfaction that in a consensual way should obtain each of the participants in the commercial operations of the market. In each country there are thousands of markets, each has its own characteristics and obviously in many of them the phenomenon of equilibrium does not occur because there are abundances and deficiencies and, consequently, different prices that reflect those abundances and deficiencies.

8. What determines economic performance?

In the end, what determines the economic results is the economic policy established by the government in each country. This shows that the State is really the one who has the last and most important word in economic matters in all the countries of the world. The degree of economic freedom is fundamental. The great failure of communism and socialism has been the excessive intervention of the state.  With the exception of the Nordic countries, the rest of the socialist experiments have all ended badly.  

9. True balance and success

The true balance and success lies in allowing the free play of the market to the point where it does not affect the general welfare through monopolistic, oligopolistic, speculation and usury practices; A very important historical example in that sense was the New Deal policy established by President Franklin D. Roosevelt in the United States to recover the economy after the Great Depression of 1929.

The State must also promote economic and social development through its different policies, promoting private initiative, protecting the rights of workers, and directly carrying out fundamental activities such as security, health of the population and education, which is the most important social justice mechanism.