The numbers game: a primer in economic theory

The power of economics - does it always have to be a balancing act?

"Economics is common sense made difficult by economists," Robert Muldoon once observed. You can see his point; the walls of figures and impenetrable graphs can appear to be an exercise in self-indulgence. But economics is underpinned by concepts that, once understood, can offer a window on a new world.

For those of us not ensconced in finance, the OCR, surpluses et al are background noise, affecting us at a basic level (how much we pay a week on the mortgage, whether we get an Accommodation Supplement) but offering very little else of interest. No pun intended.

But the thinking - and thinkers - behind economics can be fascinating. And the concepts around how to allocate finite resources in the most effective way possible are vital for understanding how we live today.

Modern economics can be traced back to the 18th century: a world of tin mines where woman pulled carts like horses and children worked 14-hour days in horrifying, filthy factories. It is from this world that the godfather of economics injected a measure of order, developed the concept of supply and demand and postulated the power of profit.

A confirmed bachelor with googly eyes, Adam Smith was prone to fits of absentmindedness. He once wandered 24km in his nightgown before being brought back to reality by the peel of church bells. But the Scottish thinker emerged as a luminary in a period when feudalism was being replaced by mercantile capitalism and his thinking paved the way for understanding what would become the economic system of capitalism.

His best-known work, The Wealth of Nations, put forwards the argument that an "invisible hand" underpins supply and demand. This quasi-mystical force, in Smith's view, underpins a market-based economy in which people are led towards jobs they have aptitude for and which are most aggregable to the interest of the society.

It's an individualistic view but tempered by social good. By looking out for our own interests and providing services or goods that others want to purchase, Smith believes we meet the needs of wider society. The "wealth of nations" is created when countries are populated with individuals who strive for betterment and meet their own needs. People direct whatever wealth they have towards ventures that are most likely to earn them the best returns, with the lowest risk.

Smith believed in a market that was comparatively free of intervention. But he wasn't, as some might think, a proponent of the laissez-faire, unregulated capitalism, commonly known as neoliberalism – the free market system that dominates today.

Anthony Endres is emeritus professor in economics at the Faculty of Business and Economics at University of Auckland. He says Smith believed the market should be tempered by sympathy and shouldn't be ruled by capitalistic monopolies.

In his early book The Theory of Moral Sentiments, Endres explains, Smith points out that humans cannot thrive in a predominantly market-based economy if they do not have the capacity for "sympathy''.

"Sympathy for those who are unable to make or enforce contracts in the market, thereby being exposed to force and fraud, the poor and downtrodden in the commercial society, and those who are exploited unfairly by the 'mean monopolising spirit' of merchants in the market economy," he says.

He and the British economists who followed him (from David Ricardo to John Maynard Keynes), believed some form of government intervention was needed to ensure that naked self-interest didn't lead to exploitation or the hardship of others.

It was French thinkers (Jean-Baptiste Say, for example) who favoured an unregulated market, a laissez-faire economic system unchecked by government. And this liberal form of economic theory offered the inspiration for the free-market system that typifies Western economics today.

The globalisation of the market hasn't been without victims. It's seen as the cause of huge inequality, the scourge of the natural world. The free flow of "capital" and movement of work offshore has led to a backlash that brought the likes of nationalist, protectionists like Donald Trump into power.

When Milton Friedman and his "Chicago School" introduced their free-market ideology in the 1970s, this school of economic thought overthrew an economic paradigm that had been dominant since the Great Depression.

Meanwhile, Keynes, an upper-class sophisticate with close ties to London's Bloomsbury group, theory put private enterprise in the forefront but called on governmental intervention in times of recession and depression. He believed that if governments borrowed money at times of high unemployment to give people more jobs, this could stimulate the economy positively. But by the 1970s, unemployment and inflation increased concurrently, followed by an oil crisis in 1973.

Friedman's thinking had been developing and his free-market theory was awarded the Nobel Prize in Economic Science in 1976. Fashions changed; economic thinking began to shift towards Freidman and his cohorts. Friedman et al believed that monetary policy, rather than macroeconomic policy set by government, should dictate the market. They opposed minimum wage rises (feeling they achieved the opposite effect as their intention, as employers tightened their belts and employed less people); tariffs, they believed, harmed consumers who were forced to pay higher prices for products.

You see Friedman's influence in the US-backed Chilean revolution of 1973, led by free-market-oriented Augusto Pinochet against socialist president Salvador Allende and in the policies of Ronald Reagan in the United States and Margaret Thatcher in the United Kingdom.

Former MP Sir Roger Douglas talks about life during and after politics, which included serving as Finance Minister and leading far-reaching economic reforms. Photo / Dean Purcell

In New Zealand, this pro-competition, free-market ideology played out in the policies of Finance Minister Roger Douglas under the 1984 Labour Government, with wide-reaching results. In Labour's second term, the David Lange-led party put in place a series of radical reforms (including the corporatisation of many State-Owned Enterprises) and the offshoring of many New Zealand factories which led to the loss of many jobs. The fast and furious reforms would end up disillusioning many of Labour's supporters, ending in a major fracturing of the party.

We are left with the legacy of these radical changes. The New Zealand of the 21st century operates in a global market, comparatively free from interventions, especially when contrasted with the Muldoon era of price and wage-fixing that preceded "Rogernomics".

Economic theory, and its outworkings, are evident in all our all lives. And our day-to-day engagement with economics is most likely to be via the news media, and the "pop" economists who translate the theory into language that we are more likely to understand.

As chief economist for ANZ, Sharon Zollner's role is charged with making sense of the figures that the bank economists produce and disseminating them to the wider public.

She's somewhat of an anomaly as an economist. The low percentage of women in economics - it's estimated only 20-30 per cent of undergraduate economic students are female – is a persistent issue for the discipline. She remembers being one of three women in a post-graduate course with 12 men.

Zollner says that the role of an economist ranges greatly in scope. There are the highly theoretical economists, who exist in the ivory tower of academia; the competition economists who work in such areas as power sector regulation; and the "pop" economists, like her, who provide a window on our economic prospects.

It's a slightly derogatory term but one that she believes is fitting.

ANZ Bank chief economist Sharon Zollner. Photo / Dean Purcell

"My role is to be an economic storyteller, taking the complex theory and communicating it in a way that avoids jargon."

She wasn't always a fan of economics but was good at it and, to her, it offered more career prospects than English. But it only really came to life for her when she interned at the Reserve Bank at the end of her third year at university.

"It can be a dry and abstract subject but [during this internship] I was able to see how highly applicable it was to people."

She says that economics, at its most basic, is a way of understanding what a society, business or group of people have and establishing work the equitable and effective way in which to allocate it.

Part of her role is working with economists to look at factors that could impact our wellbeing - international and national trends and threats. And currently, there are a few.

Zollner says the combination of drought conditions with the Covid-19 virus represents a "significant vulnerability" for the New Zealand economy.

"Our small, open economy is like a little cork in the economic ocean. The last two recessions have occurred as a result of drought conditions coupled with a global threat like Covid-19. There is massive uncertainty around what will happen with this virus, it may blow over quickly but it may not."

Economic literacy, she believes, can mean the difference between weathering such storms, and going under.

"If people have economic and financial literacy, they are less likely to take risks at the wrong time. Those who don't heed warnings around the possibilities of the economy going down will be the ones who suffer the worst."

For all their esoteric numerical languages, economists have a serve a vital function. By calculating the possible permutations of any given situation, they seek to improve the outcomes of groups, businesses or entire countries. As such, it's worth noting what they say – their window on the world may prevent you from expensive mistakes.