Theory, economic policy, and evidence

The International Review of Applied Economics is devoted to the practical applications of economic ideas, and to considering the interaction between empirical work and economic policy. These links between economic ideas, empirical work, and economic policy are of course complex. One might think that ideas would lead to policy, influenced in an evidence-based way by empirical work. But it is often the other way around, with ideas created to justify policies, with the empirical work either skipped or commissioned to support the policy. And once those ideas have been created, they may shape subsequent policies for generations. Hence Keynes observing that ‘Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist’ (Keynes 1936), and indeed, his General Theory was written to change the way people thought about economics, driven by Keynes’s realisation that orthodox economic policy – the ‘Treasury view’ – was disastrously wrong.

Writing a book in 1936 in the depths of the global depression and mass unemployment, arguing that the capitalist system does not automatically create full employment, would otherwise appear to be an exercise in – as John Cleese would say – stating the bleeding obvious. But to get a shift in policy required a change in thinking.

Unfortunately, that change in thinking was not as fundamental and far-reaching as it should have been, and the Treasury View remained lurking within the supposedly Keynesian textbooks, so that when what is now characterised as the ‘neoliberal’ onslaught began, the Keynesian world view was not as robust as might have been supposed.

Several of the papers in this issue contribute in various ways to showing how a careful use of the evidence suggests that the sweeping (or lazy) assumptions of mainstream theory do not match the empirical reality, and thus how a more appropriate policy agenda might be formulated. Cunha, Haines and Da Silva point out that mainstream economics generally assumes that international financial integration will be economically efficient and hence beneficial, but their analysis of the effects on the Brazilian economy suggest there are various detrimental effects, including exchange rate volatility, increased country risk, and loss of GDP. Aiello, Cardamone and Pupo show that what happens within the ‘black box’ of the firm matters, and the likelihood of achieving greater firm-university collaboration is influenced positively by firms using meritocratic management practices. Opoku, Ibrahim and Sare find the argument that financial development will promote economic growth is not born out by the evidence, which suggests the causal relationship between the two developments is much more complex. Rolim’s study of the US economy suggests that reversing the redistribution of income that has taken place away from workers would stimulate the economy.

Baussola, Ferretti and Mussida reappraise the argument that European labour markets need to be made ‘more flexible’. By reviewing the standard methods of measuring labour market flexibility, and thus of comparing the concept between countries, they find ‘inactivity’ is currently ignored by these standard methods, and when it is included, a quite different picture emerges, with a great deal of flexibility in European labour markets, but with much of this going into and out of inactivity, which the current approach fails to appreciate. The need is, rather, for policies aimed at reducing employment instability, particularly in continental Europe.