Updating macro-economics

Adam Smith’s analysis in the Wealth of Nations gave birth at the end of the eighteenth century to economics as we know it today. As a moral philosopher, he wanted to provide a better understanding of how to fight poverty. While most social thinkers insisted that wealth could only develop from agriculture, Smith observed that the beginning of the industrialisation process was the key and priority to promote the Wealth of Nations for the future. And he was right.

Let me propose here first some non-conventional considerations to promote the Wealth of Nations in the future, reconsidering some key economic issues:

• Economics did not start as a general social discipline concerning wealth, but as a consequence of the industrial revolution. An important historical event, it had a glorious development for over two centuries, but essential conditions and connotations began to change a few decades ago. Contemporary economics is very different than the economics of the Industrial Revolution. We live now in a Service Economy.

• This implies that the economic theories and analysis based upon the classical industrial framework needs a serious, fundamental reappraisal. Many economists have long agreed that macroeconomics in particular is in a crisis. In addition, there are no clear economic explanations why after 1973, the rate of growth in GNP terms, in the “industrialized countries”, has declined from an average of 6% or more to 2% or less. What are really the causes for the recent crises? There are many explanations, but they are only partially convincing.

• We propose that some basic reference issues need to be reconsidered: What is economic value and how is it produced today? What is productivity and how is it measured? Do the main indicators that are used today still reflect the reference to the industrialized manufacturing system? We still calculate value-added on the basis of the remuneration of production factors (cost of machines and labor for an automobile) and productivity measures (the possibility to produce two cars instead of one in the same time period), but all this is less and less relevant.

• Classical theory divided all economic activity into three sectors (agricultural, industrial-manufacturing, services). But today services (as a consequence of technological development) have become the main production factor in ALL activities, accounting in total for 70 to 80% of all economic value produced (regardless of the way it is accounted for).

• Granted that services as we now know them could not exist in the absence of tools and equipment, and vice-versa, the development of the modern Service Economy implies that there has been a reversal from manufacturing to services as the main contributing factor for the generation of economic wealth.

• Services began to make a significant contribution to the generation of wealth about 80 years ago with increasing investments in R&D. Services play a more and more important role within any manufacturing activity for control, planning, security, etc. Services are essential for storage, distribution, logistics, and maintenance.

• The outcomes of service systems and products are used over a period of time, so often their full cost is not known at the time of sale. Here the UTILISATION value over an extended period of time becomes a crucial determinant of real performance up to and often including the last step of disposal, which is, in fact, an ex-post production cost.

• It is essential to also remember that for over a century after Adam Smith, economics emphasized the supply side (how to “produce wealth”); but for the last century, in particular from the time of Keynes, it has concentrated on demand — first in its solvable version, and then extended more and more into its insolvable version, hence the present financial crisis.

• The service economy implies in any case, first of all, an understanding of the supply side.

• Concerning the present indicators of “value added”, such as GNP, more and more of it measures in fact “deducted value” (linked to scarcity produced by the industrial system itself, under the form of reparations, reconstructions, depollutions, etc.). On the other side, by enhancing performance, technology and communications essentially act as services, where the results need to be measured through specific indicators which are only partly accountable in the “value added” system. It is clearly obvious that the accounting of the wealth of nations has to be deeply revised.

• I have suggested in various publications two main possibilities: the first is to adopt indicators integrating into economics other social disciplines (sociology, demography, psychology, etc.); the other — remaining exclusively in the field of monetarized systems, but incorporating the concept of utilisation value in the service economy, using analogue methods of calculation or evaluation similar to those of insurance companies to assess the value, risk and uncertainty associated with future events, for which they collect a premium.

• In any case, in the old industrialized countries, there are daily hundreds of articles and papers on the hope of generating a new wave of “traditional” growth — the optimists speak of 2 or 3% growth — within the same traditional frame of reference, i.e. the classical industrial revolution perception. No vision has yet emerged calling for something practically and intellectually new and invigorating. The future is preparing something much better, and this is bound with the need for rethinking of economics — for a new and better understanding of the Wealth of Nations.

• For details on all these issues, see “Documents on the Service Economy” in the site: www.newwelfare.org (English edition)

Orio Giarini, Editor-in-Chief