What makes an economy healthy?

A persistent theme in economic reasoning is to fail to define what is meant by 'the economy', and in particular its conception of economic health. Here are four possible definitions of economic health, of which only the first (and until the recent boom, the second) seems to be taken at all seriously by politicians:

1. Monetary measures of economic activity such as GDP or profitability. This is essentially a financial view of the economy.
2. Then there is the definition of economic health based on the so-called real economy. This involves measuring how well we are achieving the creation of the right mix of goods and services to maintain the economic system itself - as measured by growth, profitability, government income from taxation, employment levels, international competitive position, and so on.
3. Then there are measures of how well the economy contributes to creating a healthy society. This would include measures of human well-being, social solidarity, and so on.
4. Finally (so far), there are measures of how well the economy contributes to creating a sustainable society. This takes into account society's position in the natural world.

Note that, in Definitions 3 and 4, I say that these measures 'would' be used. It's not that such measures don't exist - on the contrary, we seem to be awash with studies of human happiness these days (a great deal of it summarised in The Spirit Level, by Richard Wilkinson and Kate Pickett 2009). However, such measures have no impact on actual economic management, so they hardly count (yet).

Definitions 1 and 2 - the 'financial' and 'real' economy definitions - look very similar, in that the definition of health itself remains much the same, with only the diagnostic differing much. Yet the differences are fundamental, for when economic health is measured and managed exclusively in terms of money (GDP, profit, and so on), booms will always turn pathological. And that is exactly what we got, of course, as soon as the momentum was dominated by those with no other grasp of the economy than as a device for making money - the investment bankers, the corporations whose profits come primarily from treasury operations, and so on. And of course, our economically naive politicians followed suit - endlessly grovelling to these alleged Masters of the Universe -and so, of course, ensuring that they would indeed be the true masters of our economy.

All the same, measuring economic health in terms of the second, 'real' economy definition of economic health means limiting ourselves to another strictly economic definition. This one is taken from a previous age when the link between the economy and society was not taken for granted and even economists did no believe quite so slavishly in markets, or even profitability, as a measure of economic health. This post-War era was was killed by globalisation, though the final coup de grâce was administered by Thatcher, Reagan, the Chicago School of economics and the Washington Consensus adopted by the IMF, World Trade Organization, World Bank and many national governments.

The strength of the 'real economy' definition of economic health is that it does at least tether the economy to society. Of course, business itself was constantly bucking against it, but fortunately the post-War social consensus was that society needed to be actively managed and the economy was not the same as business. When that ceased to be true - when national economies suddenly found themselves confronted with global competition and national businesses were allowed to shift capital and operations offshore - and big business discovered that it held all the important cards, the post-War social consensus promptly collapsed. The financialisation of the economy followed all but automatically, and the rest is history.

Hence also the weakness of the second, 'real economy' definition of economic health - that it ties the economy to society but does not define it in terms of what it does for society. So although politicians and economists regularly insist on the social connection, this is seldom more than verbal reassurance. Conversely, little attention was paid to what would happen if national economies were internationalised while there was no global consensus, let alone global political apparatus, for managing an increasingly global economy. As usual, the economists (a body of intellectuals blessed with 20:20 hindsight) completely failed to predict what happened next.

So as soon as the circulation of capital and resources starts to enter new circuits, the entire political class was thrown into disarray, excepting only those for whom it was axiomatic that markets should be allowed to determine everything (Thatcher and Reagan) and those for whom capitalism had always been suspect (socialists, etc.). The immediate effects were that everything was sacrificed in the name of an extremely narrow definition of economic health (implicitly Definition 1, of course) - the privatisation and marketisation of the public sector, tax breaks and subsidies for fabulously wealthy corporations and individuals and, far from the economy serving society, coming to see society as being reduced to an appendage to the economy. Happy days indeed.

It was twenty years before the new market/Washington consensus was able to dominate the entire political spectrum (at least as far as parliamentary politics was concerned), but there was never much doubt that it would.

So the second definition of political health was always unstable. As for the third - the creation and maintenance of a healthy society - it never really got a grip on economics. At a rhetorical level, of course, it was always argued, even by the most extreme market enthusiasts, that the full marketisation of the economy would benefit us all. But that merely meant that connection was assumed - the same as definition number two. On the other hand, the actual method chosen to hand it over - handing over society's key assets to big business, deregulating markets, and so on - not only assumed that Definition 3 could be achieved by equating it with Definition 2 but all but made it inevitable that the economy itself would quickly lapse into Definition 1 - the source of our current woes.

But even if Definition 3 could have been enforced by political control over the economy - a doubtful proposition, given the lack of clear understanding by mainstream politicians and economists of how capitalism really works - it is now clear that this would not have been enough. For centuries we have paid little attention to society's impact on nature, even though it has sometimes reached the point where a civilisation has effectively committed environmental suicide.

Nor was this simply a matter of ignorance. We have had the materials for a true environmental science for as long as there has been a science of any kind. Liebig and others were already explaining how we were constantly undermining the natural basis for society in the middle of the nineteenth century. It was not hard to see or understand: you measure some basic facts, such as how much (literal) crap is being poured into the sea instead of being pumped back into the land, that told you how quickly you were depleting the soil, and that told you how long we could go on like this.In economic terms, the problem was that no strictly economic measure of well-being was going to capture society's ultimate sustainability if if did not measure the long-term, inter-generational impact of economic activity.

Basically, economic metrics look equally benignly on social 'bads' and goods, just so long as someone was paid to create them, and ignore both when no one is paid either to create them or clear them up. Nor do they generally take into account how we squander resources, not only using up what should be our children's heritage but even turning what one would have thought were inherently renewable resources such as fresh water and fertile soil and seed into non-renewable resources.

The reason we didn't pay attention to this kind of insight was simple but not obvious. Even while we were creating the science needed to understand just how unsustainable our economic system was, the economic system itself was throwing up both theoretical and practical barriers to understanding this fact. On the one hand, economic theory was claiming that a combination of market-driven efficiency and resource substitution meant that the economy would take care of all these problems automatically, so they did not need to be managed by anyone else, and society could blithely look the other way. On the other, by the time the size of this mistake was clear, we were too committed to an economy that was driven by constant growth to be able to see or admit that we were indeed in deep trouble.

So major studies of the (un)sustainability of the economy start to be published in the nineteen sixties and seventies - Only One Earth, The Limits to Growth, and so on - and here we are, four decades later, still unable to take them in. Rather, the dissonance between any realistic solution to the problems of environmental sustainability and capitalist economic viability have rendered the problem too complex, the forces aligned with the wrong answer too powerful and those charged with solving the problem have been rendered too scared, too confused and too weakly equipped to deal with it.