I am writing this column sitting in Vienna, a city that was home from 2015 to 2018. I am back for a short trip, a nostalgic one, to a city that my wife and I have come to like a lot.
Vienna, once capital of the Austro-Hungarian empire, is known for its history and culture. A city famous for its café culture, home to Mozart, Beethoven, Klimt, and Freud and a refuge for aspiring revolutionaries such as Lenin, Stalin, and Trotsky. But this is not about them.
It is about some grand practitioners of my own discipline, ie economics. I shall talk about three of them, the oldest of whom was born exactly 150 years ago, and the youngest of whom passed away just 30 years back.
These are classical economists from an earlier era, but their writings are profoundly relevant for understanding the Bangladesh economy of today.
The oldest of the trio is Joseph Schumpeter. Born in February 1883 in Triesh, a town in what is now the Czech Republic, Schumpeter studied law and economics at the University of Vienna. After a distinguished career in Austrian academia, and a short stint as the country's finance minister in 1919, Schumpeter took a teaching position in Germany in 1925. In 1932, he accepted a position at Harvard and moved to the US, where he eventually died in 1950.
There, during his lectures, he would often tell his students about the three great ambitions he had in life: To be the best lover in Vienna, the most skilled horse-rider in Austria, and the greatest economist in the world. With his characteristic aplomb he would then declare that he had failed in only one of these, leaving his students to guess which one!
For us though, what matters most is his incisive contribution to the understanding of economic change and the dynamics of economic development. He made a seminal contribution to our understanding of entrepreneurship, distinguishing between those who were merely businesspeople and those who were truly entrepreneurial. In his classic book, The Theory of Economic Development, first published in German in 1911, he defined entrepreneurs as those who ventured into something new, be it the introduction of a new product or a new method of production, the opening of a new market, the discovery of new sources of raw materials or the pioneering of new ways of organizing business.
A key insight of Schumpeter is the idea of recombination. In The Theory of Economic Development, he writes: “The carrying out of new combinations we call ‘enterprise'; the individual whose function is to carry them out we call ‘entrepreneurs'.” In a static economy, people carry on with the same combinations of inputs to produce various things. In a dynamic economy, entrepreneurial people see new possibilities in what is already there; they recombine existing things in ways that are more productive. A great contemporary example of this is Steve Jobs whose iPhone does not involve any dramatically new technology, but the creative use of technologies that already existed.
Related to this is the idea of creative destruction that Schumpeter introduced in his other classic, Capitalism, Socialism, and Democracy, first published in 1942. In simple terms, this means destroying something to create something of greater value -- a phenomenon that lies at the core of a dynamic economy.
A good example from Bangladesh, that I have previously cited in this column, is the closure of the Adamjee Jute Mills. The land on which Adamjee stood was used to set up the Adamjee Export Processing Zone. It started operating in 2006, and within seven years, ie by June 2013, jobs created there were more than that lost when the jute mill closed. By June 2019, it was almost three times that. The export-oriented factories in the EPZ do not require heavy subsidies as was the case with the Adamjee Jute Mills. Moreover, many looms of the Adamjee Jute Mills were subsequently used to set up small jute twinning mills in North Bengal, helping the industry to shift from the traditional product mix of hessian, sacking and carpet-backing cloth towards jute twines which have better market prospects.
Bangladesh's future economic trajectory will depend a lot on whether such processes of creative destruction leading to better allocation of resources are allowed to play out. At the heart of such processes will be entrepreneurs who are constantly looking for ways to recombine old things to produce new things, such as using the land in Adamjee to set up new kinds of factories, and the looms of Adamjee to make a different type of jute products.
Sixteen years younger than Schumpeter, Frederich von Hayek was born in Vienna in 1899, right at the turn of the century. Like Schumpeter and many other Austrian intellectuals, Hayek, the winner of the 1974 Nobel Prize in Economics, did not stay in Austria for long. But, irrespective of whether he was in Britain, the US, or Germany, Hayek's thinking reflected the early teachings of the Austrian school of economic thought.
Hayek, who has many significant contributions to the literature on economics and political philosophy, is well-known for his defense of the free market and critique of socialist systems. Underpinning this stance, which has earned him both praise and criticism, is a set of useful insights. I shall highlight just one of these, ie the knowledge embodied in market prices.
One of Hayek's concerns was the challenges of economic management under different economic systems. To do their job well, economic managers must have a good understanding of economic dynamics. They need to know the movements in different economic variables, such as industrial and agricultural production, exports and imports, and jobs and livelihoods. They must also have some idea of how these variables may move in the future, and how their policies may affect such movements.
They must also understand what lies behind such movements. For this, economic managers would ideally need to talk to thousands, perhaps millions, of economic actors. They would need to grasp what consumers, producers, traders, and financiers are thinking, and how they are deciding what to buy, sell or produce. This is a difficult task. Collecting information on all relevant dynamics and undercurrents is a herculean, if not impossible, endeavor. Surveys can be done, and data can be collected. But no matter how extensive such efforts, these may only reveal the tip of the iceberg.
What can economic managers do in such a situation? How can they marshal the knowledge they need for effective economic management? Hayek's answer -- let the market provide that knowledge.
In a famous paper “The use of knowledge in society”, first published in the September 1945 issue of The American Economic Review, and considered one of the top 20 articles published in the journal during its first 100 years, Hayek argued that market prices do not just tell us how cheap or expensive a good or service is. The price of a good or service, at any one place or time, reflects the thoughts and perceptions, the desires and fears, and the decisions and actions, of thousands of economic actors. The price of a single product at any given time thus contains an enormous amount of knowledge, which cannot be captured even by the most comprehensive of surveys.
This may appear surprising, even ludicrous, to some. How can a single price contain so much knowledge? Hayek argued that while, in the final instance, the price of a product is determined by the interaction of two economic actors, ie the buyer and seller of the product, the decisions of these actors are influenced, even if in a subtle manner, by the thoughts and perceptions of many others. All this knowledge gets transmitted into the price of a product.
Hence, Hayek argued, economic managers should allow markets to freely determine prices, which they should then use to guide their decisions. To be sure, Hayek was aware of market failures and why regulation is often needed to address such failures. He argued for minimizing market distortions so that prices can effectively perform one of their most useful functions, ie generate information that economic managers need. Hayek concluded that socialist economic systems were bound to be inefficient because their economic managers are deprived of this valuable source of knowledge -- a view that earned him both praise and scorn.
But how is this insight relevant for Bangladesh? Let me provide just one example. Consider the high rates of inflation currently causing much hardship to many Bangladeshi households. The galloping prices of goods reflect the balance of market supply and demand, the former hampered for many reasons, and the latter expanded, economists argue, due to high government spending and low interest rates (the so-called 6-9 policy).
But there is more to this. Rising inflation creates an expectation of more inflation to come. Economic actors then rush to the market to stock up before prices rise further. This exacerbates the supply-demand imbalance. In other words, the observed price dynamics do not reflect just the current market conditions but also the expectations of thousands of economic actors about what may happen in the future. Such inflationary expectations are, in turn, formed as citizens process different types of information (and misinformation). In short, by studying the price movements carefully, economic managers in government can get useful insights not just about current market dynamics but also the future expectations of thousands of economic actors. They can then take their policy decisions in a more informed and judicious manner.
Hayek's faith in the free market was based on the notion of self-regulating markets. This view was contested by Karl Polanyi, an Austro-Hungarian economic anthropologist. Three years younger than Schumpeter and thirteen years older than Hayek, Polanyi is most well known for his classic work The Great Transformation, first published in 1944.
Polanyi talked about an important dialectical process very relevant for current day Bangladesh, ie the advance of the market economy vs. the push for social protection against increasing marketization. He made a very useful distinction between the economy and the market (not everything in the economy happens through the market) and between the economy and society. Polanyi argued that for much of human history economic processes were embedded in society and culture but that, during the industrial revolution and the subsequent push for economic liberalization in the 19th century, the economy came to dominate society.
Writing in the backdrop of the two great wars of the 20th century, Polanyi suggested that this reversal of roles is not sustainable. It was no surprise to him that the great transformation engendered by the industrial revolution in the 18th and 19th centuries, was followed by catastrophic conflicts in the first half of the 20th century.
As we try to understand present-day Bangladesh and chart our future course, there is much we can learn from the grand classical economists of Vienna, the well-known Schumpeter and Hayek, but also the lesser-known Polanyi.
Bangladesh has a vibrant market-based economy that has created opportunities for millions of Bangladeshis. Schumpeter has lurked in the background. We have seen the unleashing of an entrepreneurial spirit, and processes of creative destruction where entrepreneurs, from small farmers to large conglomerates, have worked with what exists to create something new. As policy-makers endeavor to create an environment to further stimulate such entrepreneurship, they may heed Hayek's advice and make judicious use of the vast information provided by the marketplace and price movements. They will also have to remember Polanyi's message about the complementarity of market and society and ensure that the future development of the market economy accounts for the societal and cultural reality of Bangladesh.
Going forward, one of the major subjects of public discourse in Bangladesh will be the complementarity between market-liberalizing policies, a modern regulatory framework, and an effective social protection system -- all essential for harnessing the benefits of a market economy. So far, discussions of these topics have happened in silos. The time has come to bring the conversations together.
