Skip to 0 minutes and 10 seconds Most people take an interest in economics, because they wanted answers to questions like, why do we have poverty, or unemployment, or inequality? And how do we deal with them? How does government encourage raising living standards, and how do they avoid slumps? What should be the role of business and the state? Economic theory as set out by economists can sometimes explain. But economic policy, acting on the theory, is for policymakers, politicians, or technocrats responding to them. And here, I want to look at some of the important political figures in recent history who were responsible for major changes in the way economic policy was made. One of the really great economists of modern times was John Maynard Keynes.
Skip to 1 minute and 2 seconds Keynes was interested in politics. He was a supporter of the then Liberal Party. And he himself famously said that all practical men of affairs are slaves of some defunct economist. But the slaves do the work of implementing economic ideas. And Keynes’ own ideas gained support by being associated with Roosevelt’s New Deal. One way of distinguishing the politician, the policymaker, from the economist is the type of language they use. A politician will typically say, we must do x. Or, I pledge to do y. Now, these are normative statements. They’re expressions of belief or faith or values. And economists will say, on the other hand, that if we do a, then b is likely to happen.
Skip to 1 minute and 57 seconds Or, if that pledge is carried out, these are the costs and these are the benefits. Now, these are positive statements. Positive statements are scientific in character. They’re based on evidence and statistical tests. To give some typical examples, Brexit campaigners argued, we must leave the European Union to take back control. This is a normative statement. Economists, on the other hand, produced studies which showed, or tried to show, that if we leave the European Union, everybody will be x pounds better off or worse off. Now, these are clearly positive statements. In practice, things are more complicated.
Skip to 2 minutes and 41 seconds Some economists feel sufficiently strongly about their theories or statistical evidence, that they come out on one side or the other in a topical political debate, making normative statements. There were “remain” economists, and some– rather fewer– Brexit economists. Since they are supposed to be acting on scientific evidence, it raises the question about how could they disagree? Well, scientists do disagree, and interpret evidence differently. That’s why there are scientists, for example, who deny global warming. Though, there aren’t many of them. In the case of Brexit, there are good reasons why people can have an honest disagreement about, for example, how a change in the relationship with Europe would affect inward investment, since the link is quite difficult to quantify.
Skip to 3 minutes and 36 seconds Or there may be a disagreement about how easy it is to offset the impact of withdrawal through an intervention by the Bank of England. Or about how rapidly and substantially the balance of trade would respond to a fall in the value of the pound. Sometimes, however, economists do fall into the trap of letting their own values get in the way of positive scientific analysis. One of the most common cases is the hostility of most economists to rent control. Now, they will argue– quite correctly– that holding down rents will simultaneously increase the demand for rented accommodation, and reduce the ability or willingness of landlords to provide it. Hence, increasing scarcity.
Skip to 4 minutes and 28 seconds Now, economists are usually right that the effects are negative, but not necessarily. It may be that those effects are small, and that large numbers of tenants are able to enjoy greater security and reduced fear of arrears and eviction. A different set of priorities. Let me take another example. Most economists tend to be advocates of free trade, and I’m one of them. Now, the reasons based on the logic of greater efficiency through specialisation, are brilliantly set out in Adam Smith’s Wealth of Nations. And they were developed by David Ricardo, who introduced the idea of comparative advantage.
Skip to 5 minutes and 10 seconds But it was actually a politician, Sir Robert Peel, the Prime Minister, who put these ideas into effect in 1846 when he abolished the Corn Laws, the Corn Laws that protected British landowners. And this is the subject of an essay below. But we economists need to be careful about how normative advice operates, even though in this case it’s usually good advice. And history tends to show that. Public concern isn’t always about efficiency and economic benefits. Governments have to be mindful, for example, of security concerns. During wartime, trade is usually controlled. And comparative advantage can also be changed and developed in a different way.
Skip to 6 minutes and 1 second This was a key insight of the American statesman Alexander Hamilton, and more recently, the leaders of Japan and China. There’s also a risk that politicians take economic theory and evidence without the necessary qualifications. In other words, positive economics misused. For example, President Reagan and Mrs. Thatcher both justified cutting taxes on rich people on the basis of a Laffer curve, whereby, according to a Professor Laffer, who was an American economist, lower tax rates produce higher tax revenue. Now, the stories told of how President Reagan was persuaded by a graph drawn on a table napkin. In practice, the Laffer curve isn’t very scientific, and it only applies in some countries, some of the time, at certain ranges of tax.
Skip to 6 minutes and 57 seconds But it gave economic credibility to a politically very controversial policy. So how can positive economics based on evidence be useful and improve the way that governments make policy? There are several ways in which it can. First, it can expose the logical fallacies or simplistic analyses which often lie behind what are apparently common sense ideas. A good example is the so-called lump of labour fallacy, why many people, and indeed, many governments, believe that the number of jobs is fixed, and that’s why they oppose automation or freer trade. This is analysis which treats labour markets as inflexible and not part of a larger economic system, which can be used to show, of course, that this is not true.
Skip to 7 minutes and 54 seconds And the evidence of economic history reinforces that conclusion. Or there’s the housewife economics, which argues that because in uncertain times it can be prudent for a household to increase savings to prepare for a rainy day, that everybody should increase their savings, including the government. Now, there is here what’s called the fallacy of composition. What’s true for an individual may not be true for the whole. The common sense approach may lead to an overall reduction in spending and overall demand, and that leads to a slump and unemployment. What’s grandly called Keynesian economics has, at its heart, a rejection of this so-called common sense.
Skip to 8 minutes and 40 seconds Second, the focus of positive economics on consequences– if x, then y– is especially useful in forcing policymakers to think of the costs of what they do. One of the most fundamental ideas in economics is opportunity cost– the value of the things we could do if we didn’t do x. Even in sophisticated democracies like ours, general elections tend to be an auction of promises. Our party will spend money on ABC, or it will cut taxes D and E. Now, these promises have opportunity cost. Usually, hidden spending increase and tax cuts are usually paid for by spending cuts and tax increases somewhere else.
Skip to 9 minutes and 28 seconds A third point is that there are some reasonably settled relationships, which do enable estimates to be made of the impact of policy changes. These relationships sit at the heart of the models of the economy. They can be limited to the variables themselves, so-called partial equilibrium. Or part of an economy-wide system, which we call general equilibrium. Examples are the consumption function, which links the total amount of spending in an economy to income. Now, this is useful for estimating the impact of, say, a change in value added tax. And others, the link between the demand for labour and wages, which is used by bodies such as the Low Pay Commission when it sets the minimum wage.
Skip to 10 minutes and 17 seconds A further example is the Phillips curve, which links the level of unemployment to inflation. Now, all of these relationships can change over time. They can be affected by wider influences. And so they need to be treated with care. But they are better guides than pure guesswork or political dogma. But it’s the politicians that act on this economic evidence, and it’s their prejudices and outlook on the world, which set the direction of economic policy. And in the rest of this course, we’re going to look at some important political figures who radically changed that economic policy.
Politics and Economics
Sir Vince Cable is the leader of the Liberal Democrat party in the United Kingdom and the Member of Parliament for Twickenham. He was Secretary of State for Business Innovation and Skills for five years and is an Honorary Professor of Economics at the University of Nottingham. In this course, he explores the link between politics and economics.
This course explores the link between politics and economics by analyzing the work of seven leading political figures – Alexander Hamilton, Sir Robert Peel, The Meiji Emperor, Franklin D. Roosevelt, Ludwig Erhard, Margaret Thatcher and Deng Xiaoping - which have used economic theory to design economic policy. Throughout this course, you will be introduced to the method of economics applying economics tools to policy relevant questions.
In this introductory film, Vince makes the distinction between normative and positive economics by using the example of Brexit. For those who are not familiar, Brexit was a referendum held in 2016 by the citizens of the United Kingdom over their membership in the European Union.
After watching the film, tell us in the comments section whether you think politicians more often use normative or positive statements when advocating for their policies. Do you find these arguments persuasive?
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