The Nobel Prize in Economics: Time for a Return to Social Democracy

An award created as a concession to market-minded bankers needs to recognize the centrality of social-democratic policies to the wellbeing of industrialized economies
Avner Offer and Gabriel Söderberg, The Nobel Factor: The Prize in Economics, Social Democracy and the Market Turn (Princeton University Press, published 5 October 2016)

Neoclassical norms have acquired the halo of science from the Nobel Prize in economics, endowed by the Swedish central bank in 1968. The prize came out of the long-standing strife between Sweden’s politically dominant social democracy and the country’s business elites, a local instance of the class conflict prevailing in the West more broadly. In the 1950s and 1960s, Sweden’s central bank had clashed with government over credit policy: Government prioritized employment and housing; the bank, led by an assertive governor, worried about inflation. In compensation for restrictions on its authority, the bank was eventually allowed to endow a Nobel Prize in economics, as a vanity project for its tercentenary. And the committee awarding the prize was captured by a group of centre-right Swedish economists.

The Nobel laureates make up a high-quality sample of economists, which enhances the credibility of the prize — as does a rigid parity of awards between right and left, formalists and empiricists, Chicago and Keynes. But several surveys of economists’ opinions show them to be well to the left of the committee’s balance.

Assar Lindbeck, the Swedish professor who dominated the awards, initially adhered to social-democratic thinking, but later turned away from it. In the 1970s and 1980s, he intervened in Swedish politics, invoking microeconomics against social democracy and asserting that high taxation and full employment were leading to disaster. Along with other economists, he persuaded some of the social democratic leadership to change course, and distracted attention from the real policy error of deregulating credit in 1985. A deep financial crisis followed in the 1990s, which anticipated the global one of 2008.

Lindbeck’s doctrines tallied with those of the IMF, the World Bank, and the U.S. Treasury, which motivated the Washington Consensus. Privatisation, deregulation, and free capital movement enriched business and finance, led to acute crises and reduced welfare in client economies. Economists did not anticipate that these policies would also instigate a ‘corruption eruption’. Corruption then spilled over to the developed countries, and is now pervasive. This corruption is the unintended consequence of rational choice me-first premises, and has done a lot to harm the common good and to foster mistrust in governing elites. Swedish political scientist Bo Rothstein has petitioned the Swedish Academy (of which he is a member) to suspend the prize until the effect of economics on corruption is investigated.

Social democracy is not as deeply theorised as economics has been, and makes no pretensions to parity with physics. Yet, it has been enormously successful in keeping economic insecurity at bay. With sparse academic credentials, and in spite of relentless attacks, it remains an indispensable framework for providing social and public goods. In this task it is more efficient and more equitable than free markets. But its thin intellectual support means that even nominally Social Democratic parties to fail to grasp how well it works.

Markets reward the wealthy and successful. Social democracy is premised on civic equality, and this creates a bias for one-size-fits-all policies. But since the 1960s, social democracy has sought to incorporate an element of choice as well. Because its methods are indispensable and because economics appears to be so compelling, the two doctrines have mutated to accommodate each other, but their marriages are not happy.

Even then, economics is not left alone to set policy in most developed countries, where pragmatic and effective systems of social democracy ensure that about 30% of GDP is allocated to provide for employment, healthcare, education and pensions. Economists invoke a trade-off between equality and efficiency, despite its empirical falsification. But for economic security, the problem is not equality; it is how to support dependency over the life-cycle, i.e. in childhood, education, ill health, and old age. The social democratic solution is cross-sectional transfers from producers to dependents by means of progressive taxation, and investment in health, education and infrastructure. The neoclassical solution is to transfer entitlements over time by means of financial markets. But long-term contracts are rigid, fallible, and costly. The social Democratic alternative is cheaper, more flexible, and endorsed by voters.

In economics, the choices of self-seeking individuals trading in markets scale up to an efficient equilibrium. This model is an ambitious undertaking that has to be judged as a qualified failure, both analytically and empirically. In response, many economists have moved into laboratory and field investigations. The gain in validity is purchased at a cost in generality: localised experiments cannot replace an overarching social vision. Economics needs to accommodate social democracy. A good start would be to acknowledge this in the Nobel Prize awards, maybe reaching beyond economics — as the committee has done before.

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