Edward Hadas

Stable pairwise matching won Lloyd Shapley and Alvin Roth the Nobel prize for economics. It is an idea that is simple, slightly illuminating for economists, occasionally useful for everyone – and profoundly misleading.

The matches in question are between members of two groups, for example potential husbands and potential wives, or medical school graduates and hospitals that might employ them. The “stable” is defined narrowly: the pairing off is stable as long as no individual can find a way to improve his or her situation by trading partners. What counts as “improvement”? The game theory of Shapley and Roth does not really address that question.

The simple idea, demonstrated by Shapley a half century ago, is that under certain conditions a methodical process of elimination – many rounds of tentative pairings – leads to stability. Take a pool of equal numbers of would-be brides and grooms. The men keep on proposing to their favoured women. At first, only the irresistible men garner acceptances from the most appealing women. Gradually, though, each less attractive man will win the favour of some less attractive woman, who accepts the sad reality that she cannot do any better. At the end, while many people may wish they had a different spouse, no one will be able to arrange a trade. Any alternative pairing will be less desirable than the current one to one side or the other. That is exactly game theory stability.

The research is illuminating for economists because it teaches them that money is not needed to arrange an efficient allocation. Economists used to assume, and many still do, that cash markets are the best way to ensure that everyone is able to satisfy as many of his or her desires as possible. Shapley showed that in matching, under certain conditions and by some definitions, nothing more is needed than clear and consistent rankings of potential partners.

The illumination should be slight. Indeed, it probably takes a few years of economic training to be surprised that monetary values do not always lurk behind effective allocation decisions. After all, parents need neither game theory nor cash to divide a cake among the children. Money rarely plays a direct role in deciding who gets what in government programmes.

Roth showed that the Shapley technique is socially useful. He designed “clearinghouses” which have successfully matched doctors with hospitals, students with schools and kidney donors with recipients. The accomplishment is real, but limited. Roth’s clearinghouses require unusual conditions – not only consistent rankings of possible partners but also a single pairing decision, limited and basically equal information on both sides and the existence of alternatives which are fairly close substitutes.

Such clearinghouses are not suitable for most important allocation decisions. Marriages, for example, feature in Shapley’s original explanation of the technique, but few people would actually sign up for any sort of marriage clearinghouse. The choice of a life mate is too complicated to be trusted to an algorithm. In the West, the uncertainty of courtship is an integral part of the effort to create a bond that will be truly stable – able to last through thick and thin.

The unsuitability of a marriage clearinghouse hints at why the Nobel-winning idea is deeply misleading. It, like game theory as a whole, relies on four false assumptions about human nature.

First, satisfaction is defined in terms of preferences which may be arbitrary, unfair and temporary. That is dangerously simplistic. The hardest part of match-making is evaluating what the various candidates are really like and getting a good fit. Marriage match-makers, employment headhunters and university admissions officers earn their keep.

Second, game theory is individualistic, paying almost no attention to the social context of decisions. People, however, are profoundly social. Allocation shapes, and is shaped by, society. A serious study cannot simply ignore society’s needs and desires.

Third, the allocation games have no moral dimension. People are free to think about morality when they draw up their lists of favourites, but just as they are free to think about astrology. In reality, though, people should search for the truly good, and not merely for the pleasurable. In general, they do make an effort to be virtuous.

Finally, pairwise matching makes allocation into a non-monetary form of what economists call a market process: a collection of interactions between a large number of independent and fundamentally self-interested potential providers and users. In reality, such markets often make people uncomfortable. They prefer to decide on who gets what by co-operation, through committees or consensus, or by trusting some authority – whether a parent, a boss or a bureaucrat – to make just decisions.

There are times when it is helpful to treat life like a game. Shapley and Roth deserve thanks, and their prize, for showing how to design a good game. Life, however, should be taken more seriously.

Whoever wins the U.S. presidential election will preside over a relative decline in the country’s global economic position. He should, but probably will not, accept the inevitable.

There was a time when almost everything about the American economy set the world standard. In 1960, The United States was the world’s largest market. It had by far the most developed infrastructure, easily the best educational system and undoubtedly the most business-friendly government. It was the source of most innovations, from safe highways and comfortable suburban houses to computers and advanced pharmaceuticals.

Those days are long gone. The creation of the European Union has left the U.S. market in second place. Overall, the infrastructure in Europe and Japan is at least as advanced. The United States is still the global leader in many areas of industry, education and government, but it has fallen behind in some, and the gaps have narrowed in all.

The automobile industry provides a good example of the trend. Researchers Joyce Dargay, Dermot Gately and Martin Sommer point out that in 1960 the United States had 411 vehicles for every 1000 people, while Sweden, then the European leader, had 175, only 43 percent as much. By 2002, the U.S. ratio had almost doubled to 812, but the ratio in the current European leader, Italy, had increased much faster – to 656 or 81 percent of the U.S. level. In Japan the ratio moved from 19 to 599. Almost inevitably, in the interim the United States lost its clear pre-eminence in automotive design and manufacturing.

The principal cause of the end of American economic predominance is the sincerest form of flattery: imitation. Other countries have learned from the American teacher, and copying proved easier than creation. Some of the students learned so much that they are now teachers. The catch-up was only hastened by American economic weaknesses, most notably insufficient investment in infrastructure, a persistent trade deficit in manufactured goods and financial mismanagement.

None of these problems as well as the painfully slow recovery from the 2009 recession is likely to have much effect on the basic pattern in the next presidential term or for many terms thereafter: the U.S. economy will continue to advance, but much of the rest of the world will advance faster. The largest relative losses will no longer be to Western Europe and Japan, which are basically in the same economic position as the United States. They are rich and slowly getting richer despite financial, social and demographic weaknesses. However, about 80 percent of the world’s population live in countries which have a long way to go to catch up to global standards. Some may languish, but others will move fast enough along the path towards prosperity to ensure that America’s lead narrows.

What should the next President do?

He should recognise reality. The truth may be painful, but it is better to know. An American president will be better at promoting American interests if he does not assume he has the right to set the global agenda on trade, finance or technology. Recognition will also make him better at calibrating military and diplomatic ambitions to economic reality. The president might just be more motivated to address domestic economic weaknesses if he has no notions of inevitable national superiority.

After he admits the hard truth, he should relax. Not only is there nothing much to be done, but the relative decline of the United States is basically a good thing. More extensive prosperity is good and lesser global economic inequality is even better. Americans who believe in the nation’s manifest destiny to teach the world the right way to live can be pleased that one part of the American dream, the tremendous economic enterprise, is becoming more of a global reality.

Finally, he should act responsibly. Although the American economic era is slowly ending, the country has a disproportionate residual importance. Its currency is the global reserve and its research universities remain the world’s best. In many parts of the globe, America is considered almost as much the archetypical land of opportunity as it was a few decades ago. A president who wishes to conserve as much of the country’s position as possible would do his best to nurture these legacies. For example, he would try to reverse the current fiscal and monetary policies, which might have been designed to make the dollar untrustworthy.

Unfortunately, neither candidate shows much sign of taking my advice. At least in public, they vie to show more confidence in American greatness. Such boosterism may be an electoral necessity, but it is poor preparation for dealing with the challenge. In the 19th century, France suffered from refusing to recognise that the Napoleonic conquests marked the peak of the nation’s influence. The UK repeated the mistake in the 20th century. The United States looks all too likely to do the same.

The winner of the presidential election should do something about U.S. unemployment. The current rate of 8 percent is high by America’s historical standards, and that measure does not capture the gravity of the problem – too many people have spent too long out of work or have decided to leave the workforce because jobs are too hard to find. European leaders face an even greater challenge. The EU unemployment rate is 10.4 percent, and during the last decade it has been below 7 percent for only half a year.

What is to be done? Neither Mitt Romney nor Barack Obama has a clear plan. The Federal Reserve has an idea, but it is hard to see how $40 billion a month of newly printed money will actually help create jobs. I have an alternative approach: EAST. It is both an analysis of the problem and a solution.

E is for Efficiency. The industrial economy continually makes more stuff out of less labour. More efficient workers, machines and systems constantly add to consumption, and constantly subtract jobs. The lost labour has mostly been dangerous or tedious, so there is little to regret.

Still, the job drain presents a social challenge. Unemployment is an affront to people’s need to do something meaningful. Fortunately, for more than two centuries advanced economies have more or less managed to compensate for increased efficiency. New jobs have been created to provide consumers with additional goods and services. Labour-intensive bureaucracies have expanded in law, finance and government. The available labour has been shared out over more people, leaving more time for education, leisure and retirement.

A is for Asymmetry in the labour market. Despite the success at keeping people busy, job destruction remains much easier than job creation. Destruction is the natural result of the relentless increase in production efficiency. It also fits in with the productivity mindset; employers are always thinking of ways to cut unproductive headcount.

Conversely, job creation is much less natural. While companies often need to add staff in order to grow, it is still risky for employers – the new employee may not earn his keep. Tax and benefit payment reduce the odds of success. New initiatives are often thwarted by social inertia, powerful incumbents, unsympathetic banks and smothering regulators.

S is for Surplus, the structural surplus of labour. The asymmetry of job creation and destruction creates a perpetual risk of persistently high unemployment. The actual problem is much more serious in poor countries than in rich ones, but unacceptable levels of unemployment are always and everywhere a threat. Crises are especially dangerous. When U.S. financial system stumbled badly and when the Greek government ran out of money, old jobs were quickly lost – and replacements have not yet been found.

Economists often get this wrong. They worry far more about insufficient GDP, a mythical problem in already rich advanced economies, than about the structural challenge of a potential oversupply of labour. The blind spot leads to backwards analysis. It is misleading to say that a decline in GDP caused the current U.S. unemployment problem. The predominant causality goes in the other direction: excessive job destruction led to a fall in GDP – and the GDP recovery will come only when new jobs are created.

Finally, T is for Target. Employment is best increased by making it a direct target of public policy. The old communist governments did this well. They provided jobs for all. Their method was frequently wrong – the police and domestic spying services were big employers – but the goal was right. Non-communist economies should also make full employment the first goal of economic policy.

In the long run, the goal can only be reached through a determined fight against labour asymmetry; governments should discourage job destruction and encourage job creation. Germany, where unemployment has shrunk steadily for six years, has shown the power of relatively minor changes in regulations. In the United States, hiring is probably less of a problem than firing. Law, custom and lenders all push employers to rush to let people go when times are tough. The incentives should be pushing them in the opposite direction.

The long-term goal is not to make factories less productive; that would be mad. It is to support valuable activities, from highly skilled crafts to labours of care, which are too easily judged to be marginal or “uneconomical” because they are insufficiently efficient.

In the short term, the government should be an employer of last resort, just as it has become a lender of last resort. It can create jobs directly – for example through public works projects – or indirectly by subsidising new jobs in the private sector. Right now, all the Fed’s newly created money is flowing into the financial markets. The next president would be wise to look EAST and put cash into the pockets of newly hired employees.

Barack Obama and Mitt Romney put the economy at the top of their campaign agendas. They have both focused primarily on labour – the high rate of unemployment. The attention is deserved, but other parts of the economy should not be ignored. There is the worrying decay of the nation’s capital stock – the physical, social and financial infrastructure. There is also something wrong in the consumption side of the economy, but there is a heated debate on just what the problem is.

Many commentators believe that the middle class, which makes up the bulk of the population, has a big problem: a decline in living standards. After all, the Census Bureau reports that the $50,054 median household pre-tax income in 2011 was 9 percent below the all-time peak, adjusted for inflation, reached 12 years earlier. That decline in income is so large that it must have led to some erosion in the typical family’s consumption.

Even if purchasing power really had declined by a few percent, the slide was from such a high starting place that loud complaints about deteriorating lifestyles would be unseemly. In fact, though, the median income measure distorts consumption reality. It omits services received without cost, for example healthcare provided by the government and insurers. It excludes the effects of changing taxes and shrinking household sizes. It underestimates the value of technological improvements – think mobile phones and the internet – and of the vast expansion of new, now-cheaper housing during the bubble.

These adjustments are almost certainly large enough to offset the reported decline. So the middle class doesn’t need a lecture on the virtues of making do with less. The adjustments also explain the lack of massive political indignation, even if there is evidence of minor irritation, at declining incomes. The placidity is not a sign that the American middle class has found stoic fortitude in the face of adversity. Rather, it is a reasonable response to consumption which is not really falling.

On the left, the common view is that the rich, or more precisely the widening gap at the top of the income ladder, is the nation’s leading consumption problem. For the top 1 percent of earners, income – after taxes and government transfers and adjusted for inflation – has multiplied four-fold since 1980, while the median has not even doubled. The disparity might be reduced by statistical adjustments, but the trend is real. The rapid increases in pay for celebrities, top executives and financial professionals are typical.

President Obama sometimes criticises this increase in income inequality in favour of the rich. That may be politically astute, but it dodges the ethical question of whether, and why, this change is undesirable. For egalitarian purists, it is, on principle, but the gains of the wealthy do not necessarily imply that the less well-off have fewer economic opportunities. For those who worry that the country is becoming a plutocracy the increased concentration of wealth is clearly a step in the wrong direction, but the wealthy have always had a great deal of political power in the United States.

There are good reasons not to worry too much. The actual increase in consumption which comes with an increase from very great to awesome wealth adds almost nothing to an already high quality of life. Further, more people have joined what might be called the luxury class. In 2011, 4.2 percent of American households had a pre-tax income of more than $200,000. In 1968, the proportion above that threshold (in 2011 dollars) was a mere 0.7 percent.

Another increase in inequality – against the poor – receives much less attention. For four decades until 2000, poverty was waning; the proportion of households with an income under $15,000 dollars (at 2011 prices) fell steadily. In the new century, though, the trend has clearly reversed. That is a real problem, even though the typical consumption of America’s poorer families is high by global standards.

The median cash measure understates the poor families’ decline. They have also lost out on cost-free services. Compared to richer Americans, today’s poor receive worse health care, leave their free public schools earlier and have less effective police protection. It is also worrying that today’s poor are also socially needier than the poor of their parents’ generation; overall they are less able – or, as some Republicans would have it, less willing – to help themselves.

Only a major social commitment could address this problem, but fixing poverty is low on the agenda of both candidates. Their indifference is politically sound – the bottom of the economic heap will not win them the election – but morally regrettable. Complaints about the supposed income losses of the middle class sound self-serving. Whines about the gains of the rich are often tainted with envy. A serious commitment to the poor would show that generosity still thrives in the world’s richest country.

Revolution was not on the agenda when the Second Vatican Council of the Catholic Church opened on Oct. 11, 1962, almost exactly 50 years ago. However, the gathering marked the start of a new era, not only for the world’s largest centrally-run religion. During the following years, the hope for a better, freer world led to everything from the sexual revolution to the Prague Spring, from African independence to the hippie culture of Woodstock. A half-century on, it seems a good time for an economist to take stock.

The economy was not the top concern of the ’60s would-be revolutionaries, but calls for a new society had two revolutionary economic implications.

First, like so many other parts of the established order, the economic “system” was to be overthrown. The target was clear enough in Eastern Europe – the Communist planned economy. Elsewhere, the economic villain was harder to pin down, although it was often assumed that “capitalism” was intrinsically evil – heartless corporations and excessive materialism in the West and post-colonial exploitation in the Third World. It was time for radical change; if not a return to some imagined pre-industrial communal paradise then at least a massive refusal to become cogs in the machine. It hardly seemed to matter then that dissidents in the East were longing for what protesters in the West were loathing.

One of those 1960s dreams has come true. Communism is gone, save for Cuba and North Korea. Otherwise, the “system” appears well entrenched. Corporations, larger and more impersonal than ever, have extended their reach in a globalised world. Developing economies may be less in thrall to the former colonial masters, but indigenous entrepreneurs are just like their western exemplars. The communes are closed or have gone commercial. Alternative careers are rare, money and finance ubiquitous.

The second economic revolutionary demand was for the abolition of poverty in the midst of post-War plenty. This sentiment led to the foundation of the United Nations World Food Programme in 1961 and the U.S. government’s war on poverty in 1964. The post-Vatican II Catholic Church was one of the keenest promoters of global economic “Justice and Peace”.

That dream has come closer to reality. True, hunger still plagues a billion people, but abject poverty has diminished as GDPs have risen around the world, and safety nets have helped the needy in richer countries. Nonetheless, the 1960s’ revolutionary and religious fervour made only a minor direct contribution to these improvements. Developing countries primarily copied the practices of rich countries while the welfare state mostly expanded existing programmes.

It might sound like “the system”, which was not overthrown, has actually been good for the world. Was the rage against the machine all in vain, and the idealism unnecessary? I think not, and not only because of the collapse of the Soviet economic model.

While most of the children of the 1960s eventually signed up for work within the system, many did not completely abandon their higher aspirations. As a result, the counter-culture spirit has infiltrated the corporate world. Capitalism has proved flexible enough to change in response to its critics. In the 1960s, theory Y management – the idea that employees should be encouraged more than disciplined – looked original. It is now obvious. Corporate claims to “social responsibility” may often sound hypocritical, but executives would not even bother to pretend if they didn’t believe that companies should do more than merely provide profits for shareholders. “Don’t be evil”, as Google’s founders put it, is a 1960s-style slogan that most bosses would now endorse.

The 1960s commitment to the elimination of poverty has also borne fruit. Without it, companies would be less willing to offer better conditions for their employees in poor countries, or to demand better conditions for their suppliers’ employees. Without it, western politicians would be more hostile to the expanding power of China and former colonies. Without it, there would be even more hostility to economic immigrants struggling to earn a decent living in rich countries.

Of course, history does not repeat itself. Last year’s global Occupy Movement didn’t amount to much. In a way, that failure is a sign of the greater success. The decade’s economic idealism has had enough influence that calls for radical change now sound silly.

Nonetheless, idealistic dreamers are still valuable. They can remind the world that the ultimate purpose of a prosperous society is not wealth for its own sake, but something better. I would suggest three goals for the grandchildren of the 1960s. First, the battle against pollution is not yet won in rich countries and has only begun in the developing world. Second, there is an urgent need for a financial system which doesn’t have greed as its only engine. Finally, the gulf between rich and poor is still too wide. It is too often forgotten that a poor man’s rise from wretched poverty does more good for the world than a rich man’s latest bauble.

Economic development is not a simple matter. If it were, the comforts and security of developed economies would be enjoyed by more than one-seventh of the world’s population. Political extremists, especially successful ones, help explain why development has benefited only a minority.

Over the last two centuries, many groups which started out tiny, extreme and persecuted ended up in power. Think of radical socialists in many nineteenth century European nations or the colonial freedom fighters in much of Asia and Africa. The rebels varied in their beliefs and sophistication, but they shared the conviction that the pre-existing social order was irredeemably corrupt. The groups were typically built around a hard core of true believers, with larger groups of fellow travellers and vague sympathisers, some of whom rose to quite high positions.

It is much the same for economic revolutionaries in very poor countries. At first, small bands of devotees emerge. These are people dedicated to the capitalist work ethic – discipline at work, innovation in enterprise and efficiency in production. These dreamers also aim to overthrow the economic arrangements that went before – the feudal hierarchies, economically stultifying social restrictions, aristocratic waste and primitive technology. Economic revolutionaries are invariably more selfish than their political counterparts, but they share the desire to turn everything upside down.

Industrial prosperity has fed the growth of these hard cores over the last few decades. Most poor countries have developed some industries and spawned at least a few billionaires. Nearly everyone in power now claims to be a sympathiser with the capitalist urge. Few speak out directly against industrialisation and economic modernisation.

Still, many countries which have escaped the most wretched poverty seem incapable of moving up to the highest level of prosperity. Only a few have emerged from what economists call the middle income trap. Mario Pezzini of the OECD describes these countries as ones with “a myriad of institutional and socio-economic deficiencies”. There are shortages of trust, skills, law enforcement and honest politicians, while social structures which restrict economic change remain firmly ensconced. In these countries the professional culture which is normal in developed economies remains revolutionary.

Indeed, a good way to describe this trap is as an incomplete economic revolution. There are three problems, each with corresponding political failures.

First, core revolutionaries have a hard time. Trotsky, the most idealistic leader of the Russian Revolution, was exiled (and eventually murdered) by the unimaginative Stalin. In a very different context, Lakshmi Mittal left his native India to build his steel empire in less hostile lands. Inside developing economies, powerful but inefficient incumbents often thwart the plans of the most imaginative industrialists. When economic fervour is allowed to flourish, it is often limited to groups identified as outsiders, for example among the overseas Chinese in many Asian countries.

Second, the hard core often softens when it gets into power. There is a long litany of once-idealistic leaders who led their countries into stagnation or worse. The list grows of businessmen in China, Brazil and India who have decided there is more to be gained from playing along with the powerful rather than disrupting existing arrangements. Managers at Brazil’s Petrobras, once considered a global quality operator, now find it easier to yield to the counter-revolutionary cash demands of its government owner.

Finally, revolutionaries often play establishment roles badly. The African National Congress in South Africa is the latest to discover that injustice is easier to condemn than to correct. Many industrial leaders in developing economies find it hard to move from subverting established economic structures to the construction of the open networks of trust and skills which underlie full industrial prosperity.

What can be done to complete economic revolutions? The political analogy suggests there are many bad paths, from the French Revolution’s terror to Mao Zedong’s proclamation of a Cultural Revolution after almost two decades in power. The rise of social democracy in continental Europe provides a more encouraging precedent. A tiny group of radical Marxists somehow metamorphosed into respectable politicians who could win democratic elections, neutralise old aristocracies and soften up new industrialists without compromising their hard core goals of social safety nets and universal public services.

The Social Democrat example suggests that the middle income trap may only be temporary. Perhaps the better educated children of today will find the values of the capitalist work ethic less alien. They could become economic revolutionaries with much less of the rebellious spirit than was required a generation ago. The critical challenge, though, will be to avoid the economic equivalent of the two great European wars which helped destroy the old and bring in the new order. Perhaps today’s economic authorities will yield more gracefully to this revolutionary force.

Speeches by Chinese Communist Party leaders are great opportunities to play “buzzword bingo”. Hu Jintao’s July 23 policy summary was replete with such phrases as “socialism with Chinese characteristics”, “Deng Xiaoping Theory” and “Scientific Outlook on Development”. But the sloganising is more than empty rhetoric. The speech, echoed elsewhere, shows the outgoing leader wants the CCP, and the country, to escape from might be called a Marxist trap.

The trap has three parts. The first is the core Marxist belief that economic considerations come first while culture and everything else lag far behind. These days, many non-Marxists also put the economy first, but Chinese leaders are especially loyal to the simple claim that GDP growth equates to progress. Hu’s focus on scientific development, for instance, is shorthand for putting higher production before all other goals. His other big buzzword – harmonious development – is not a tribute to the traditional Confucian notion of cosmic harmony, but a call not to let inharmonious social disorder slow material progress.

The second part of the Marxist trap is the Communist Party’s monopoly of power in government and its final authority over everything in society. That predominance has been taken for granted by virtually everyone in the top leadership since the foundation of the People’s Republic in 1949, although the thinking comes less of Marx himself than his teacher G.W.F. Hegel. Hegel believed that the state would and should eventually take over the roles traditionally played by the various organisations of civil society: family, church, guild, cultural and special interest groups. Lenin added the claim that the Communist Party is the vanguard of this all-encompassing state, so there is neither need nor space for other voices.

The final piece of the trap was set by Deng Xiaoping, the second leader of communist China. His endorsement of rapid and chaotic capitalist development, later know as socialism with Chinese characteristics, may not sound Marxist – Deng’s doctrinaire opponents in the CCP were certainly horrified. But Marx himself believed that only bourgeois capitalists had the fervour and motivation required to industrialise a predominantly agricultural economy. In Marx’s day, the bourgeois and the communists were enemies, but the CCP has tried to co-opt the private sector by admitting leading industrialists into the Party.

By some standards, the Deng version of Marxism has worked very well, far better than the Leninist approach, adopted in the Soviet Union and its satellites, which gave the state control of all the means of production. China’s GDP has increased remarkably rapidly for almost four decades. There has been little social discord and the Party remains in firm control.

Still, as the Party prepares for the arrival of a new generation of leaders, its Marxism looks far more constraining than liberating. The narrow focus on production has led to the neglect of such important matters as corruption, environmental depredation and quality control. The Party’s suffocation of civil society has neutered campaigns against abuses. It has also impoverished intellectual discourse, an important failing in a society still in the throes of the dramatic transition from poor to rich; from traditional to contemporary. And the Party’s acceptance of capitalists, careerists and opportunists has accelerated a decline in ideological fervour.

Hu is certainly aware of the challenge. He noted that the country will soon be “a well-off society” with a more demanding and restive population. However his new buzzwords are unpersuasive. The all-encompassing Communist Party is incapable of building China into “a power of socialist culture” or of ensuring “the people’s extensive rights and freedom”. The Party is trapped because it can neither let civil society flourish nor do what civil society does.

If the Marxist trap is not sprung, China will be left lame and angry. The government will become more oppressive and more of a kleptocracy, stultifying society and depressing the economy. Escape, however, requires a truly revolutionary change. In buzzword-speak, the CCP and China should no longer remain “unswervingly on the socialist path”.

What new path should the Middle Kingdom take? There are some bad ideas about, for example militaristic nationalism and a reversion to more Leninist economics. The western way, towards the European and American social model, is much more attractive. China, much like its Asian mentor and rival Japan, could end up with a mixed economy, a pushy but not omnipotent state and a society in which any lack of higher values is largely a private concern.

In a way, a choice to follow the conventional path to multi-party democracy would be regrettable. China would become less distinctive and its indigenous cultural traditions would become less relevant. More significantly, this looks a bit like a road to nowhere. Apathy blights politics in rich countries while idealism is in short supply and civil society often seems stunted. However, in China no better alternative is available. For its own good, the Communist Party should abandon Marxism.

It is circa 1900. A young girl from a simple fishing village has been sold as a ’practice wife’ to the Bendoro, or local lord. When the Bendoro tires of her and expels her from his house, the girl retires from his presence the way peasants are supposed to: backwards, and on her knees.

The scene is from the novel “The Girl from the Coast”, and is based on the life of the grandmother of the Indonesian author, Pramoedya Ananta Toer. The girl suffered because the absolute authority of a petty local ruler and the accompanying indignities were considered normal. And this in a land which, by the standards of the age, was relatively refined. The Bendoro’s rules did not hold in the Netherlands, which ruled the land, but many Europeans would have shared his belief that sharp social stratification was part of the natural order of things. The Victorian author of All Things Bright and Beautiful, the childrens-favourite hymn, expressed the same sentiment a few decades earlier: “The rich man in his castle, the poor man at his gate, God made them, high or lowly, and ordered their estate.”

Times have changed. Pramoedya’s story comes from a vanished world, one in which the privileged elites were considered superior beings to the masses of ’ordinary people’. To the modern reader, the Javanese peasant bride’s humility looks demeaning and disgusting, not pre-ordained. The Bendoro’s worldview has been superseded by that of the Universal Declaration of Human Rights, which takes it as self-evident that, “all human beings are born free and equal in dignity and rights”. And the verse about “the rich man in his castle” is usually excluded from editions of modern hymnals.

Still, elitism is far from dead. Almost everywhere, a handful of people, or families, hold significant influence over politics, economics, and society. The yearning for equality that has brought about so much social and political change has put an end to the sort of bowing and scraping that Pramoedya described, but it has not prevented the rise of new ruling classes – albeit ones defined by class and profession rather than bloodlines.

Indeed, today’s elites are unlikely to have inherited a title such as Bendoro, king or prince. In Indonesia, the royal families have vestigial prestige but little political and economic influence. In their stead, a few current and former military leaders and a small group of business families – the latter almost all of Chinese origin (nine of the 10 richest, according to Forbes) – are in control. The wealth of this ruling caste is enhanced by the sort of state-granted monopolies and tribute payments that were once considered the normal privilege of aristocrats but are now often deemed corrupt.

For those who think that the desire for equality is inscribed in human nature, the new elite of China must be particularly depressing. Mao Zedong’s promise that his Chinese Communist Party would “abolish classes and enter a world of Great Harmony” is unfulfilled. The CCP has become the centre of privilege and a generator of self-enrichment. Worse, at least from an egalitarian perspective, is the exalted position of the so-called princelings, the descendents of revolutionary heroes, who hold postions of significant influence across the Middle Kingdom.

Even in the United States, the first country to be founded on egalitarian principles (slaves, women and Native Americans excluded, of course), there has always been an economic and cultural elite. Over the last few decades, it has become more powerful and grown more distant. Corruption is rare, but the law, the financial system and the accepted practices of corporate pay are all tilted in favour of the fortunate few. As in China, privilege is increasingly passed on from parents to children.

To a greater or lesser extent, elites continue to thrive. Is this persistence bad? The simple answer to that question is “yes”, since the fortunate few of the elite almost inevitably enjoy unjustly excessive privileges – more power, wealth and respect than their contributions merit. The Bendoro and other holders of inherited titles could once claim some sort of birthright, but such assertions now seem ludicrous.

Still, the elites’ persistence inspires caution. It clearly takes more than universal education in egalitarian ideology to keep them away. Excessive anti-elitism can be counterproductive. Indonesia’s post-independence regimes are far from the only examples of enforcers of rigorous egalitarianism which soon turned into new elites.

Perhaps the best hope is to tame the elites. Law and custom can be used to limit their power. Also, they can be expected to use their privileges for the benefit of all, through philanthropy, patronage of the arts and voluntary service. It might even be fair to ask the elite to find something like a common touch.

For more than three centuries, defenders of people’s freedom and dignity against the oppression of governments have frequently focused on economic depredations. In the 17th century, John Locke decried unjust limits on private property. In the 20th century, Friedrich Hayek attacked the state’s control of the means of production. The Austrian philosopher, who is a kind of patron saint for today’s crusaders against big government, was certain that men could not be free without free markets. He saw socialist economics behind all big governments, which he believed to be universally oppressive.

It is not only the enemies of powerful governments who have considered economic matters to be pre-eminent. The followers of Karl Marx disagreed totally with Hayek about government and freedom. They thought free markets led only to the oppression of the poor by the rich and that large states were needed to defend true freedom. However, like Hayek, they put the economy at the centre of the debate about the proper role of government. They merely reversed his primary prescription, with pure Marxists calling for total government control of the economy and revisionists calling for a strong state and a carefully limited private sector.

The revisionist Marxists are now known in Europe as Social Democrats and in the United States as Democrats (although few would admit this intellectual ancestry). They have had their way with the economy throughout the developed world – and the economies have basically flourished. Extensive, active and basically honest governments are good economic stewards. Big governments support and supervise the massive investment projects, complex technological standards and the astounding diversity of tasks required for industrial economies to thrive. Thorough tax systems restrain the rich while welfare benefits protect the poor.

Still, economic success is not enough to justify the ambitious and intrusive contemporary approach to government. The Big State should be judged by a more complex standard than simple material prosperity.

Hayek feared the terrible regimes of the Stalinist Soviet Union and Nazi Germany. Modern governments are nothing like those Big Oppressive States. Still, they can fairly be called Big Smothering States. There are three ways in which the government makes society less free, and in all of them the economy is the exception.

First, contemporary governments deal primarily with individuals; they generally ignore, restrict or repress what sociologists call civil society – families, churches, schools, unions and other sorts of voluntary organisations. The state increasingly guides and restricts the actions of these once largely autonomous groups. As the freedom and authority of intermediate organisations is reduced, the power and authority of the state is increased. It becomes harder to find activities which are not closely supervised by the government.

In contrast, civil society is thriving in the economy, in the form of corporations. These enterprises can develop their own cultures and communities with relatively little interference from the government. Some employees may find the cultures inane or even inhumane, but at least the state mostly leaves them alone.

Second, the Big State relies on smothering bureaucracies. Over the last three generations governments’ rule-books and administrative staffs have expanded massively. The result is that the freedom and creativity needed to educate, care, punish and help are restricted by overly rigid rules and regulations. Moral concerns are often ignored.

In the economy, though, bureaucracy is basically beneficial. Only rule-bound hierarchical organisations could organise the thousands of strangers well enough to provide the many goods of industrial prosperity. Government and corporate bureaucracies form an almost seamless web.

Third, modern governments pursue a controversial social agenda. Locke’s vision of governments which leave as much of life as possible to the governed, has disappeared. Modern states have precise goals for school curricula, health care, art, sport and sexual roles. In most domains, the state’s vision is shared by the majority of the population, but that still leaves a deeply opposed minority smothered by the state’s demands for conformity.

Once again, it is quite different in the economy. There the basic goals of the Big State – increased prosperity and ample opportunities for work – are much less controversial. I would argue for some modifications, for example less much emphasis on GDP growth and more on labour and the environment. In comparison to the debates on social policy, though, such complaints are little more than quibbles.

The crusade against big government needs a new patron. Hayek’s focus on economics makes the attack look silly, for he is complaining about modern government at its best. It would be better to draw a clear distinction between the generally helpful Big State of the economy and the Big Smothering State of the rest of society. Of course, the two developed together and remain closely entwined. It is worth trying to pry them apart – to let the first flourish and the second wither.

There is only one good, proven, way to organise a political economy in the modern world – and that’s via the Big Honest State. Right now, one key aspect of the BHS is under serious threat.

What is the BHS? As the name suggests, it is large. In quantity, the various organs of a BHS account for 30-60 percent of GDP. In quality, the state dominates education, health care, industrial policy and the financial system. The BHS is also trustworthy. Its official bureaucracies are expected to be, and mostly are, meritocratic and dedicated to the common good. A BHS, though, is far from the total government of fascists and communists. One of the defining facets of the BHS, indeed, is that it works alongside a vibrant non-state sector.

The basic BHS model has been adopted in all advanced economies and it is aspired to by most leaders in almost every developing country. Universal adoption is easy to explain: the BHS works well. It has delivered a reasonable mix of prosperity, protection and social support. It has proved remarkably sturdy. Since the Second World War, no BHS country has had collapsed into chaos, become impoverished or suffered fundamental social breakdown. The system is also popular with voters, even if many government-hating Americans hate to admit it.

However, the BHS is vulnerable to moral decay. It relies on professional integrity and hard work. Such virtues are easily lost, either through corruption or a more insidious failure of will. It is the latter, what old fashioned philosophers called spiritual sloth, that threatens the monetary side of the BHS. Until recently, the BHS was able to produce money which basically kept its value and a financial system which served the common good. If politicians and regulators don’t wake up fairly soon, these accomplishments could be lost.

There are four threats. The first is fiscal laxity. Politicians around the world have become blasé about deficits. To be fair, the record deficits have as yet done no obvious harm and the mechanism which can turn unbalanced government spending into high inflation is poorly understood. Nonetheless, the lack of concern is disturbing, and the willingness of many American politicians to drive the government to the edge of a fiscal cliff is positively alarming.

The second danger is monetary incompetence. Again, the economic effects of years of zero policy interest rates and haphazard bank subsidies are basically unknown. The theory is inadequate and the current experiment is unprecedented. However, after four years of extreme policy it is intellectually lazy to assume, as most central bankers seem to, that all will be well soon enough.

The third risk is only regional, but the region in question holds great practical and symbolic importance. The euro zone has the world’s second largest GDP, only 15 percent smaller than that of the United States, and it is the spiritual home of the BHS. If the politicians and central bankers there fail to keep the single currency together, global economic chaos would be hard to avoid.

Finally, the BHS model could be undermined by poor management of international economic relations. Trade imbalances are still large enough to create political tension, through shifts of employment, financial havoc, and the foolish investment of the funds created by surpluses. Then there are investors who move money in and out of countries at whim, distorting the economic landscape.

How dangerous are these interlocking threats to the BHS model? A collection of “should” statements supports an optimistic judgement. Politicians around the world should be able to manage their budgets back towards balance. Central bankers should be able to manage the return to normal interest rates. Euro zone leaders should manage to unify the rest of their BHS enough to support the single currency. With a little less intellectual laziness about the virtues of free trade, it should be possible to manage cross-border economic in a more responsible way.

In addition, even if developed countries wallow in financial decay, China, Brazil and other developing countries should continue to strive for something like a BHS model. If anything, they should learn from the failures of others. Indeed, everyone should be studying history and everyone should be trying to find ways to make the financial system as solid as the other parts of the BHS – although sloth also seems to be creeping into the management of health care and retirement expense.

Perhaps the best reason for confidence is the scale of the problem. In comparison to the wealth of most of the countries currently stuck in a financial quagmire, the losses involved in reconstituting a solid and sustainable financial system are modest. They should be manageable.

Unfortunately, there is a very persuasive reason for pessimism – a shortage of the virtue ready to oppose to the vice of sloth. None of these “should” statements can possibly come true unless there is far more political fortitude than has been seen for many years.