Does Pancasila Economics Have a Relative in the History of Economic Thought?

Throughout history, economic thinkers have proposed a variety of ideas. These ideas can be seen as stages, progressing from Mercantilism to classical liberalism, then socialism, and finally Keynesianism. Each stage roughly corresponds to a major historical event: imperialism, the Industrial Revolution, globalization, and the Great Depression. These economic philosophies are like well-defined blueprints. They all have clear starting assumptions and use specific methods to analyze economic issues.

Following World War I, and especially after World War II, new economic philosophies emerged. Many of these, like Pancasila Economics, positioned themselves as "third ways" – alternatives to both pure capitalism and socialism. A more prominent example is the Social Market Economy. Developed in Germany during the interwar period, this economic model boasted a strong foundation in academic theory. It heavily influenced the post-war development of both Germany and the European Union.

In contrast, several other 'Third Way' models have emerged, notable for their apparent success even without a deep academic foundation. These include the development models of the East Asian Tigers (including China's Beijing Consensus) and the Rentier-State model employed by many Arab states, especially those in the Gulf region.

Mercantilism

The 16th century witnessed the rise of European empires alongside a distinct economic philosophy: mercantilism. Thinkers like Sir Thomas Mun believed a nation's wealth grew through a constant surplus of exports over imports, with gold and silver seen as the ultimate treasures. This focus on accumulating bullion, as it's called, stands in stark contrast to the modern concept of development, which prioritizes the well-being of citizens and their access to freedoms and opportunities.

England, a dominant player, implemented mercantilist policies like the Navigation Acts, aiming to control trade by requiring English ships for English goods. This directly challenged the Dutch, who used to provide transportation services to English merchants as well, sparking the Anglo-Dutch wars.

Across the English Channel, France had its own mercantilist champion: Jean-Baptiste Colbert, Finance Minister under King Louis XIV. Colbert implemented a system known today as - surprise - Colbertism. This aimed to maximize French wealth through strategic manipulation of tariffs and taxes. High tariffs on foreign manufactured goods protected French producers, while low or no tariffs on raw materials ensured a steady supply for their growing industries. Colbert ultimately advocated for self-sufficiency in agriculture, a strong military, and the continuous expansion of French colonies.

Colonies became crucial cogs in the mercantilist machine. European nations, including England, France,the Netherlands, Spain and Portugal, established colonies to secure raw materials and captive markets for their finished goods. This often took the form of the "triangular trade" network, a dark stain on history. Resources in Africa and the Americas were ruthlessly exploited, fueled by the abhorrent practice of slave labor.

While mercantilism sparked early economic prosperity, it wasn't built to last. The flood of precious metals from exports triggered inflation for which David Hume provided the first theoretical explanation, now known as the price-specie flow mechanism. It simply states that export surpluses lead to an inflow of money (species), which pushes up inflation (prices).

Rising tea prices due to British inflation and the Tea Act, which gave the East India Company a monopoly on tea sales in America, angered colonists. Boston merchants, who thrived on smuggled tea, faced ruin if the market was flooded with cheap, legal tea. This threat to their profits, coupled with resentment over the Tea Act as taxation without representation, fueled resistance. The Boston Tea Party became the fiery response, a pivotal act leading to the American Revolution.

As mercantilism thrived on exploitation, former colonized countries were looking for a post-independent economic order that was different from that of their former colonial ruler, even if they already adopted different philosophies as well and left imperialism behind them.

Classical Liberalism

Adam Smith, initially a moral philosopher, is a key figure in classical economics alongside David Ricardo. His moral philosophy challenged the Catholic Church’s long held tenet that private property and economic competition undermines the formation of Christian values. In his first famous book, "The Theory of Moral Sentiments," Smith yet explored how virtues like humility, hard work, and respect for others are crucial for success in a competitive environment. These ideas laid the groundwork for his economic views.

Later, in "The Wealth of Nations," Smith emphasized competition as a driver of economic growth. He envisioned competition not as a brutal struggle for survival, but as a system that fosters innovation and efficiency through equal access to markets. This concept of competition as a level playing field became a hallmark of classical economics.

The decline of European dominance in the 18th century, coupled with the rise of newly independent states, especially in the Americas, chipped away at the mercantilist system. Advancements in transportation and communication made free trade more feasible, weakening the zero-sum mentality (one nation gains, another loses) that underpinned mercantilism. This shift paved the way for a positive-sum view of trade (both nations benefit), but a theoretical explanation for the advantages of free trade was still missing. This crucial framework was provided by David Ricardo's theory of comparative advantage.The theory of comparative advantage shows that if countries specialize in what they can do comparatively the best, free trade allows countries to consume more than what each country could individually produce.

Yet free trade, while benefiting countries in aggregate terms, also creates winners and losers. It is just that the winners win more than what the losers lose and it could well be that the gains from free trade are concentrated among such few people that income inequality is on the rise and with it, social instability. This is largely what happened in the global South, which specialized during the first globalization wave between 1870 and 1914 in agricultural produce which was concentrated among a small group of landowners to the disadvantage of many landless peasants.

Many, especially in the global South, see therefore in the first globalization wave a de facto continuation of the mercantilist exploitation system. Free trade, despite being an undeniable win-win situation, had therefore very little appeal to many newly independent nation states, including Indonesia.

Socialism

Socialist thought posits an inherent societal division between the capitalist class (bourgeoisie), who own the means of production, and the working class (proletariat), who sell their labor. This inherent division, according to socialists, breeds inevitable class struggle.

The labor theory of value (LTV), while not exclusive to socialists, plays a crucial role in their economic critique of capitalism. LTV proposes that the value of a good or service stems from the amount of labor required to produce it. This focus on labor leads socialists to argue that under capitalism, workers are exploited by capitalists. Since capitalists don't directly contribute labor to production, their profits from selling worker-produced goods are seen as unearned value.

However, most economists today reject the LTV, arguing that the value of a good is not determined by the amount of labor it requires to produce it, but the intrinsic value it provides to consumers. To make the point more clearly, if two miners are employed while one can mine an ounce of gold with one hour of labor and the other one ounce of granite with one hour of labor, the price of gold will still be much higher than an ounce of granite because it has a higher intrinsic value to consumers.

According to socialists, an economy based on the collective ownership of the means of production can eliminate the exploitation of workers. In such a system, the revenue generated from collectively owned production would be distributed equally and therefore ensure a fairer distribution of wealth than under capitalism.

However, critics argue that socialist economies lack a functioning price system. If everything is owned by everyone, the value of something needs to be determined by some visible hand of a central planner, as opposed to the invisible hand of the market. A central planner essentially would have to ask every citizen, how much compensation do you require for an hour of work and how much value you assign to each good? Assuming that the citizens are not at all that committed to the idea of socialism, they would have an incentive to overstate their required compensation and understate the values of the goods produced in order to get the greatest net benefit. This would then necessarily cause the central planner to work with inflated costs and deflated real prices, which inevitably will lead to shortages once the goods are produced. Aware of the challenge self-interest poses to socialist economies, socialists implemented measures like propaganda, cultural revolutions, and neighborhood watch committees.

In sum, despite theoretical and practical concerns about a socialist economy's functionality, the promise of a more just system seemed to outweigh the risks. This was particularly true for newly independent nations that lived through colonial exploitation.

Keynesianism

The Great Depression was a crucible that forged John Maynard Keynes' economic theories. As markets spiraled downward following the 1929 Stock Market crash, mass unemployment gripped economies worldwide. Businesses, saddled with excess capacity (factories equipped to produce far more than what was being demanded), faced a stark reality – a demand, not a supply, problem.

Traditional economic thought, rooted in laissez-faire principles, viewed such crises as self-correcting. Lower wages, according to this logic, would eventually entice businesses to re-hire workers, restoring full employment. But Keynes famously quipped, "In the long run, we are all dead." He argued for immediate intervention to address the short-term crisis.

Keynesian economics, in contrast to classical economics (focused on long-term supply-side factors), emphasizes short-term demand-side solutions. Through government policies aimed at stabilizing aggregate demand, economies could utilize existing capacity and reduce unemployment.

Keynes proposed two main tools: fiscal and monetary policy. Fiscal policy involves government spending on public projects, creating jobs and injecting income into the economy. Workers, with this newfound income, would then purchase goods and services, stimulating further economic activity. Monetary policy, on the other hand, focuses on lowering interest rates, incentivizing businesses to invest and expand production.

In the context of the Great Depression, Keynes believed monetary policy was ineffective. With factories underutilized, businesses had little reason to borrow, even at lower rates. This situation, known as a liquidity trap, rendered monetary policy useless. Keynes argued for fiscal policy whenever demand falls short of what existing capacity could produce, and monetary policy when existing income could support higher demand.

While Keynesian economics holds strong theoretical appeal, it's not without its detractors. The Austrian Business Cycle Theory, championed by Friedrich Hayek and later adopted by Milton Friedman's monetarism, argues that the Great Depression could have been prevented through a stable money supply. The rapid expansion of the money supply in the 1920s, followed by a sharp contraction, is seen as the culprit – artificially low interest rates fueled an investment bubble that ultimately burst.

Another critique comes from Joseph Schumpeter, who argued that government intervention can stifle innovation. Fiscal policy financed by borrowing, according to Schumpeter, drives up interest rates, hindering private investment and the crucial role it plays in economic growth. Schumpeter believed innovation and private initiative, not government spending, is the key to economic recovery.

Keynesian economics may not be a comprehensive economic philosophy, but it revolutionized how economists view short-run crisis management. Its place in history is undeniable. It was the first major school of thought to challenge the dominant laissez-faire approach, recognizing that a healthy economy requires more than just private property and competition. Keynesian thought introduced the crucial role of the state in stabilizing the economy, particularly during downturns.It was this insight that caused other philosophies to emerge as “third ways.”

The Social Market Economy

The Social Market Economy (SME) stands as a powerful alternative to the extremes of unbridled capitalism and centralized planning. Developed in Germany after World War II, the SME emerged from a deep reflection on economic history. Its vast literature dissects past successes and failures, aiming to forge a better path.

At the heart of the SME lie two distinct, yet complementary, schools of thought. The Cologne School draws on economic humanism, recognizing that individuals seek both economic freedom and social responsibility. Economic humanism is also heavily influenced by Christian Social Ethics. The Freiburg School, on the other hand, emphasizes ordoliberalism, the importance of establishing a legal and institutional framework (Ordnungspolitik) to ensure a level competitive playing field and promote equitable social development within a market economy.

The Social Market Economy (SME) stands apart from both laissez-faire capitalism and socialism. This distinctiveness is evident in how each system views economic actors and the path to economic justice within a free market.

While all three acknowledge equal opportunity as a fundamental right, their beliefs on its achievability within a free market diverge. Laissez-faire capitalism holds that the free market inherently provides equal opportunity, while socialism argues the opposite, pointing to inherent inequalities it creates. The SME takes a middle ground, recognizing the limitations of the free market in fostering a level playing field.

The most significant difference lies in the role of the state. Laissez-faire advocates for minimal government intervention, believing the market self-regulates best. Socialists, on the other hand, favor state control to achieve economic justice, often through centralized planning. The SME takes a pragmatic approach. It promotes competition by fostering equal opportunity through public investments in, for example, education and social safety nets, as well as the regulation of markets.

Imagine a race. Laissez-faire economics is like letting everyone run without any rules. Social market economics, on the other hand, sets clear guidelines (order policy) for the race. This ensures a fair competition where the fastest runner wins, not the one who elbows their way to the front. While laissez-faire might eventually correct imbalances, social market economics aims to prevent them from happening in the first place. Likewise, social market economists see in public education and mandatory participation in health care and social safety nets competition enhancing institutions, not any kind of socialism as laissez-faire adherents might call it.

It's important to remember that the labels of laissez-faire, socialism, and social market economy represent ideals, not rigid categories. In the real world, most economies are a blend, incorporating elements of both markets and central planning. For instance, the US might see itself as a free market, Germany a social market economy, and China a socialist economy. But in reality, they all exist on a spectrum – a mixed economy with a unique mix of market forces and government intervention. The key question isn't which label perfectly applies, but rather why some mixed economies thrive while others struggle. What makes a successful mix, and what imbalances need adjustment, are the crucial considerations.

Other Models

Beyond these core models, numerous development strategies exist. Two prominent ones are export-led growth and import-substitution. However, rather than representing complete development models, these strategies highlight a central focus. For instance, import-substitution aligns closely with socialist principles, while export-led growth is more akin to liberalism.

Countries like the East Asian Tigers (Hong Kong, South Korea, Singapore, and Taiwan) exemplify export-led growth. Interestingly, even some self-proclaimed socialist nations like China and Vietnam are adopting this approach. Conversely, import-substitution was popular in Latin America.

The choice between these approaches wasn't always a product of deliberate national planning. Geopolitical realities played a significant role, especially for the East Asian Tigers. Consider their situations: Hong Kong was a British colony, South Korea was the capitalist half of a divided nation, Taiwan is claimed by China, and Singapore, after being expelled from Malaysia, lacked the resources for a closed economy.

The Cold War significantly shaped the environment for the rise of the East Asian Tigers. As the sole global superpower, the United States aimed to mold the post-WWII world and prevent the spread of communism. Building allies became a cornerstone of this strategy, achieved in part through generous aid programs like the Marshall Plan for Europe. While South Korea and Taiwan lacked a similarly named program, they too received substantial US grants.

Furthermore, the US spearheaded the creation of a free-trade-based world economic order. Given the Cold War tensions in East Asia, partnering with the West under US leadership appeared as the most promising development path for these nations.

Unlike East Asia, export-led growth held less appeal for many Latin American countries. During the first wave of globalization, trade primarily enriched the landowning elite in the global South, contrasting with the rise of industrialists in the global North. The industrial revolution eventually led to the political decline of these landed elites in the North. However, in Latin America, the lack of a significant industrial sector prevented a similar transformation, hindering political liberalization.

In the post-WWII era, as industrialization emerged as the key to development, many Latin American countries felt pressure to catch up. Import-substitution appeared to be the only viable path. In contrast, the East Asian Tigers, starting with war-ravaged economies, minimal industry, and no entrenched elites, benefitted from export-led growth fueled by foreign investment. However, in Latin America, largely unscathed by the war, outward-orientation and foreign investment would have been politically risky for established elites.

The resource-rich nations of the Gulf Cooperation Council (GCC) - Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates - offer another noteworthy development experience. However, their unique economic foundation based on natural resources makes it difficult to directly replicate their model in other countries, especially as related to the financing of development.

Despite the various differences between outward-oriented, import-substituting, and natural resource rich modernizing economies, they nevertheless share one communality: A proactive role of the state. Proactivity of the state in the development literature is known as Big Push theories, of which there are two branches: Balanced and unbalanced growth strategists.

Balanced growth strategists highlight the "poverty trap" - a vicious cycle where low income leads to low savings, hindering investment and perpetuating poverty. They argue that government intervention is crucial to break this cycle.

A key aspect of balanced growth is avoiding uneven development. For instance, rapid industrialization shouldn't come at the expense of agriculture, which could lead to food shortages. Therefore, balanced growth strategies advocate for government planning to ensure all sectors (industry, agriculture, infrastructure) develop at a similar pace.

Unbalanced growth proponents, in contrast to balanced growth advocates, don't believe in the poverty trap. They argue for a different vicious cycle: "entrepreneurial disorientation." Here, the lack of clear market signals discourages investment, which in turn hinders growth. Their solution? Deliberately unbalance the economy. This strategy focuses on prioritizing specific sectors with significant ripple effects, known as "commanding heights." These include energy, steel, infrastructure, education, and public health. By jumpstarting these sectors, unbalanced growth aims to awaken dormant entrepreneurial spirit and stimulate overall growth.

Comparing these strategies, balanced growth focuses on the supply side of the economy, ensuring resources and capabilities are available across sectors. Conversely, unbalanced growth prioritizes the demand side, stimulating specific sectors to drive overall growth.

East Asia's success, often attributed to a combination of outward orientation and unbalanced growth strategies, finds echoes in the rapid modernization of the Arab Gulf States. However, India's post-independence focus on balanced growth presents a contrasting case.

The key to understanding the East Asian advantage lies in the way they utilized public investments. When coupled with outward orientation, these investments created a "market test." Failures were exposed early on the global stage, allowing for swift course correction. Additionally, East Asian economies thrived on private enterprise.

Latin America, despite pursuing seemingly similar industrialization under unbalanced growth principles, fell short. Their reliance on import-substitution shielded them from the "market test." Mistakes remained hidden, hindering timely adjustments. Furthermore, state-controlled economies prioritized actors with closer ties to the government, dampening market forces.

Which Model is Closest to Pancaila Economics?

Our exploration of development models suggests surprising parallels between Pancasila Economics and social market economics. These similarities are most striking when we consider their core objectives. Both prioritize achieving equitable social development, explicitly emphasizing the need for economic systems that foster fairness and opportunity for all.

Indonesia's Constitution (Articles 33 & 34) hints at socialist undertones, potentially contrasting Pancasila Economics with social market economies. However, Mubyarto's resistance to Sukarno's centralized planning and Suharto's top-down liberalization suggest an openness to a social market approach. This begs the question: How closely does social market economic thought align with Pancasila Economic principles?

It's important to emphasize that this comparison isn't meant to replace Pancasila Economics with social market economic ideas. Instead, it aims to reinvigorate discussions surrounding Pancasila Economics by drawing parallels with a like-minded economic tradition. Both systems, interestingly enough, challenge the extremes of pure capitalism and socialism. They share fundamental questions about the fit between these dominant philosophies and common conceptions of humanity, universal notions of justice, and the role of the state in upholding these ideals.