Current economic system fails examination by sustainability experts

Our current economic system is based on poor science and should not be used to guide government decision-making when faced with threats to existence like climate change. That’s the conclusion of a new paper led by UNSW Sydney sustainability scientists that finds our economic system is driving environmental damage and social inequality and needs substantial reform.

The research, published recently in the journal Global Sustainability, critically reviews, from a natural science perspective, the basis of neoclassical economics—the theory that underpins the neoliberal ideology of free markets, deregulation, and minimal government expenditure and taxes. Many countries, including Australia, follow neoliberalism in policymaking.

The research found that hypotheses underlying neoclassical economics—including supply-demand determined pricing, and claims like Gross Domestic Product (GDP) is a meaningful measure of well-being and markets can solve major environmental and social problems—are based on invalid assumptions and lack empirical support.

“Neoclassical economics is fundamentally flawed, bad science, and irrational in the common meaning of the word,” said Honorary Associate Professor Mark Diesendorf, lead author of the study from the School of Humanities & Languages at UNSW Arts, Design & Architecture.

“It is doing more harm than good by supporting politically powerful corporations that are driving environmental destruction and social inequality, and therefore must no longer be used for government socioeconomic policies.”

Misconceptions of neoclassical economics

For the study, the research team, consisting of sustainability experts from across scientific disciplines, refuted 10 key hypotheses and four claims of neoclassic economics on the grounds they are either contradicted by observation, lead to different results from those reported by neoclassical economics, are ill-defined, or are inconsistent. The review found each hypothesis or claim failed to satisfy one or more of these conditions—basic requirements of good scientific practice.

Co-author Thomas Wiedmann, Professor of Sustainability Research in the School of Civil & Environmental Engineering, said that neoliberal ideologies and many neoclassical economists strongly support the notion that endless growth on a finite planet is feasible and desirable.

“[However] science shows that growth in GDP is closely correlated with growth in the consumption of materials and energy,” said Prof. Wiedmann. “This leads to major environmental impacts that are threatening our life support system, the biosphere.

“The assumptions that the natural environment is an infinite resource and an infinite reservoir for waste and that it can be separated from the economic system are refuted by the findings of Earth System Science, which show that six out of nine planetary boundaries have been exceeded.”

Another claim the researchers contest is that wealth trickles down from the rich to the poor. While not all neoclassical economists accept this claim, the review cites a major study finding that tax cuts for the rich of OECD countries are correlated with higher income inequality and have no effect on economic growth and unemployment in the short and medium term.

Other hypotheses and claims challenged scientifically in the review include:

• Existential environmental threats can be managed by pricing alone when the market has failed to curb global heating and other major environmental threats.
• Humans can be credibly modeled as entirely self-interested, economically “rational,” competing individuals and able to process all available information on prices, despite scientific findings in anthropology and sociology showing that cooperation is fundamental and coexists with competition in all societies.
• Government budget deficits are generally inflationary, even though many countries, such as Japan, have historically had significant budget deficits without inflation.
• The economic efficiency ideal of neoclassical economics, Pareto efficiency, is useful, even though it’s unattainable in practice and fosters socially unjust policies.

“While a common defense of neoclassical economics is that it has advanced and no longer depends on all the assumptions critiqued, it still depends on at least three hypotheses that are not generally true,” A/Prof. Diesendorf said.

“These are the hypotheses that individual decisions can be separated from social influences, that economic systems are generally in or near equilibrium, and that neoclassical economics theory doesn’t need to explain or predict economic phenomena such as the Global Financial Crisis.”

A new economic approach is needed

The researchers said neoclassical economics can be replaced with an improved mixed economic system. However, this will require pressure on governments from community organizations and academics.

“Leaving it to the market alone is another way of saying leaving it to the 1%, that is, the big corporations and super-rich that control the market,” said A/Prof. Diesendorf. “It’s too late for the market to solve a major problem like climate change and the market cannot reduce the increasing gap between the rich and poor. We need stronger government intervention guided by genuine community consultation.”

The researchers recommend a new economic system that prioritizes ecological sustainability and social justice over economic efficiency. This would move beyond striving for increased GDP to include well-being indexes such as educational attainment and public health measures.

“If we look at Scandinavian countries, their quality-of-life measures are the highest because their governments don’t leave everything to the market,” said A/Prof. Diesendorf. “They simply spend more to provide universal basic services to their people.

“To achieve ecological sustainability, it is necessary, but not sufficient, to limit the scale of human activity in a considered way and, with it, policies to support managed de-growth. At a fundamental level, we must reduce our physical consumption of energy, land and other natural resources, which could be done while still improving the quality of life for all.”