Matthew Elliott reviews Jesse Norman's Compassionate Economics

Matthew Elliott is Chief Executive and Co-Founder of the TaxPayers’ Alliance.

Compassionate Economics: The social foundations of economic prosperity by Jesse Norman (Policy Exchange/University of Buckingham Press, 2008)  is available on Amazon.co.uk or can be downloaded free of charge through www.compassionateeconomics.com.

Jesse himself outlined the book's main themes on ConHome's Platform last week.

Over the summer, when the Conservatives had a steady double-digit poll lead and Labour was flirting with regicide, public affairs companies across London started printing glossy brochures forecasting what a Cameron Government would do. Most of these brochures were a load of tosh, with “exclusive insights” cribbed from ConservativeHome and “in-depth analysis” which could have read directly at the Spectator’s Coffee House blog. Now we are officially in recession, people wishing to spend their money more wisely and gain a real insight into David Cameron’s Conservatives should read Compassionate Economics by Jesse Norman.

The main objective of the book is to reclaim economics as a discipline which recognises the wider social context in which people operate. Traditionally, economists recognised this. As well as writing the Wealth of Nations, Adam Smith also wrote The Theory of Moral Sentiments, which highlighted “pity and compassion” as key drivers of individuals. As Friedrich Hayek – himself a lawyer and political philosopher as well as a Nobel Prize winning economist – once remarked, nobody can be a great economist who is only an economist. This is why Jesse Norman turns his fire on modern, mathematics-obsessed economists.

The third chapter of Compassionate Economics opens with a wonderful quote from Kenneth E. Boulding: “Mathematics brought rigour to Economics. Unfortunately, it also brought mortis.” Traditionally, economists used the notion that people were perfectly rational utility-maximisers operating under perfect information as simply an assumption with useful predictive powers. The problems started, according to Jesse Norman, when it was transformed from an assumption into a description of how people operate in the real world.

A good example of the danger of “rigour mortis economics” being applied directly to public policy is the failure of Tax Credits. To remind readers, tax credits are essentially means-tested payments geared to the recipients’ income. As income changes, under-or overpayments will occur. With tax credits being paid in advance, overpayments are common place, with disastrous results. The Public Accounts Committee found that the Government had overpaid £6 billion in the first three terms of the systems operation, a massive blow to some 1.9 million families who had to pay the money back. All this heartache was generated, according to Norman, by a simplistic belief that people would understand and be able to operate “rationally” under a complex system which even tax experts have difficultly explaining. Tax credits were rigour mortis economics at its worst.

The conclusion of Jesse Norman’s book is that policymakers should put compassion back into economics by recognising the subject’s wider social context. First, people should be considered as more than just walking economic calculators. Second, the social foundations of economic prosperity – independent institutions, the right balance of competition and co-operation, and widespread entrepreneurship – should be nurtured. Compassionate Economics is not a mushy prescription for public policy; it is an attempt to update Adam Smith for the 21st Century. Norman himself describes this and his previous book, Compassionate Conservatism, as “distant, modest but direct descendents” of Adam Smith’s work.

Being a conservative, Jesse Norman will agree that all humans are flawed, and there are, like in any book, a few small errors in this book. Tax revenues in 2007-08 were £545 billion, not the £450 billion mentioned on page 85. John Locke’s “mixing labour” metaphor for the establishment of private property does not limit the right of ownership to “only so much as [a person] can directly cultivate” – the existence of gold in the state of nature removes the natural constraints on the accumulation of property.

Personally, I would have been less dismissive of rational choice theory. Rational expectations don’t require that everyone be a perfect little counting machine, and not many economists really think the world works that way. As a theory, it provides the good starting point for research into how bounded rationality affects decisions – you start from perfect rationality and see where the limitations are. And it is undoubtedly a much better assumption than that of old-school Keynesianism, which relied on people systematically failing to see what Government was up to and adjust their decisions accordingly.

In fact, some would argue that UK public policy over the past ten years has been weakened by too little reliance on rational choice theory. Time after time politicians have set targets without thinking through how someone might rationally respond – welfare is a good example. And the past ten years has been a case study of the rational choice explanation for ever expanding bureaucracies. It could be said that we need the insight of rational choice theorists more than ever. But these are small flaws and differences of opinion in what is otherwise a gem of a book.

What does Compassionate Economics mean for the future public policy in Britain? For the past three years, Jesse Norman has provided David Cameron with intellectual ballast and he is one of the academic brains behind Policy Exchange, the most influential think-tank in the Conservative Party. For this reason alone, his book deserves to be widely read. The fact that he is also a Conservative parliamentary candidate in Herefordshire and will sit on the green benches of a David Cameron government – most probably the front bench – is a second reason.

But the most important reason to read, highlight and make detailed notes from this important work is that he has “Frank Luntzed” Adam Smith. Luntz, the US pollster and strategist who famously predicted Cameron’s election, wrote an important book called Words that Work. In Compassionate Economics, Jesse Norman has given people on the centre right the words that work when discussing economics. With economics now being the number one policy debate in Britain, every politico on the left, right or centre of British politics should read this book over Christmas.