More problems with economics
I thought this article in Time magazine last week by the head of the Institute for New Economic Thinking was quite good. It’s nothing new but it summarises some of the methodological criticisms of economics over the last few years.
“Economists should resist overstating what they actually know”. A lot of mainstream economists bleat on like pub bores, pretending they know all the answers when really they’re just groping in the dark like the rest of us. Dressing things in fancy technical terms helps them hoodwink us.
Which brings us to the second point: “economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation.” A lot of maths is only there because it looks cool and makes economists feel sciencey (NB. I know that’s not a word). Much better to look at what’s actually going on in the world then write about it well.
Instead of devising universal laws that are supposed to work in all places at all times, “more research on economic history and evidence-based studies are needed”. Most journals operate in some sort of imaginary theoretical world, proposing ideas that have learnt nothing from history and which aren’t tested with practical research. If I learnt one thing from working abroad in traditional agrarian economies, it was that some of the theories we learnt in university weren’t relevant there.
The final point of the article is that politics and economics are unavoidably related. It’s virtually impossible to theorise in a vacuum; to imagine that research or policy prescriptions are valid unless you take into account political context. Just as the early thinkers like Smith and Ricardo talk of political economy, not economics, ”research teams would benefit from multidisciplinary interaction with politics, psychology, anthropology, sociology and history.” I’d add philosophy, as well.
Scotland shouldn’t join the euro
At a time when Alex Salmond is touting Scotland as a progressive model for the UK, we discover that Angela Merkel wants to automatically fine eurozone countries that spend too much, to make what she considers high debt illegal and to empower Euro-judges to rule on the budgets of the 17 euro members.
The treaty would enshrine the German model of fiscal and monetarist rigour as binding on the eurozone, in effect outlawing Keynesian economics.
Goodbye social spending, redistribution or counter-cyclical government policy. Signing up for the euro would be like swapping the influence of London for rule by Brussels.
Scotland’s not going to have much space for fiscal manoeuvre as Salmond pretends. Big tax increases would force businesses south. Hefty tax cuts wouldn’t be sustainable. But Scotland would still have more wiggle-room if it stayed outside the euro and avoided a life-sentence of Germanic austerity.
If Scotland does vote for independence it should keep using pounds (which it could do whatever Cameron says). It does more trade with England than with Europe. Plenty of countries piggy-back on strong currencies like the US dollar.
True, Scotland wouldn’t have a lender of last resort like the Bank of England, and Threadneedle Street wouldn’t want to play central banker for Edinburgh without guarantees on Scottish spending because otherwise it’d effectively be writing blank cheques. But better to negotiate a flexible arrangement with Westminster than submit to the fiscal diktats of Brussels.
Utterances of the c-word
During economic crises the c-word crops up with increasing frequency. In this video Terry Eagleton and my old lecturer Alex Callinicos point out that even conservatives have again started using the term capitalism, distinguishing it as a specific system rather than a natural state of affairs. Marxists, of course, like to set capitalism apart from prior modes of production because they see it being superseded by a new and better way of organising things, hence the old joke:
Q: How many Marxists does it take to change a lightbulb?
A: You can’t change the lightbulb, you’ve got to change the system.
My other favourite is the one about the Trot caught bashing up his bog. “I said smash the system”.
The Financial Times has just run its second series on capitalism in three years. In 2009 it analysed “the future of capitalism“. The future turned out bleak: it’s just proclaimed that capitalism is in crisis.
The FT’s chief economics writer Martin Wolf hails from a very different corner of politics to Callinicos and Eagleton, so it’s entertaining to read his remedies. First, he recommends managing instability. He agrees with leftists that capitalism is inherently wobbly. The mainstream of economics had come to believe that it could tame the tiger through a competitive economy and a trustworthy central bank which convinced everyone that inflation was under control. That view turned out to be wrong, and like most economists nowadays Wolf is a late convert to Hyman Minsky, who decades ago foresaw that the very upturn which appeared to be creating newfound prosperity would itself create unsustainable levels of debt, in turn bringing the whole edifice crashing down. Wolf thinks that regulation, better government supervision and enhanced central banking can stop similar crises from happening again. I’m not so sure about the latter, given the almost unanimous deification of central bankers and their cohort in the last decade or so, and their abject failure. As I wrote to Time magazine 13 years ago, Greenspan and his friends at the US Treasury weren’t the “Three Musketeers”; they were men in suits, and they’d turned the stock market into a cult.
“Protecting the economy from finance” is strong stuff, given that a few years ago politicians and economists couldn’t wait to bow before the Goldman dollar. But shielding poor old corporate capitalism is what Wolf thinks we should do. He thinks the main banks shouldn’t be allowed leverage of more than 10 to one. Investment banking must be separated from ordinary deposit-taking and lending. People need protection from predatory mortgage sellers. I was struck by the way in which US capitalism unwound because it had preyed on the poor. Parts of Wall Street purposefully sought out vulnerable borrowers so that they could foreclose on their properties when they failed to keep up repayments.
Wolf also advocates redistribution. This is something that probably only plays to a UK rather than an American audience, but it’s vital. Propping up the poor is not only moral; it’s essential to sustaining demand during crises. Inequality is also bad for the rich in the form of increased insecurity and a fractured society. Making sure that rich people pay their taxes would go a long way, but as Wolf acknowledges, closing international loopholes is a tricky task, and one that requires international cooperation.
Wolf’s probably a bit more of a fan of the corporation than I am, but he points out that it’s central to capitalism’s success. He thinks that it’d be tricky to hold companies to account, given that it’s the freedom of their environment that’s partly the source of their dynamism. But he does recommend making pay structures transparent and he believes that boards should be diverse and well-informed. I suspect this sort of talk would invoke snorts of derision from the likes of Eagleton. For Marx, companies were both the origin of dynamism and the locus of exploitation. Hoping that they will somehow mend their ways is akin to wishing that X-Factor would become a bit more intellectual.
Probably the best insight is that: “Protecting democratic politics from plutocracy is among the biggest challenge to the health of democracies.” One of the reasons the bankers were so readily bailed out is that they bought the West’s politicians; probably more so in the States than here. Wolf is right that parties should be funded publicly. I’d say that private contributions should be severely limited if not curtailed.
Lastly, Wolf says that “open markets, monetary and financial stability, security and, above all, protection of the environment” are all global public goods and that they need to be regulated internationally — something that’ll be very unlikely in the near future. He still thinks we should strive to make capitalism better rather than accepting it for what it is.
Despite their differences, ironically much of Wolf’s analysis could have come from Marx: the acknowledgement of instability; the globalisation of capital; the injustice of inequality and the influence of business on government. Maybe Wolf isn’t so far removed from Callinicos and Eagleton after all. Yet despite admiring the unfashionable consistency of Marxists, I find Wolf more interesting. Yes, Marxists aren’t afraid of using the c-word and they know the next calamity is around the corner. But their obsession with the system means they don’t always bother with nuanced policy prescriptions. Persistent bearishness is a bore, and it’s too easy.
It’s helpful to think of capitalism as a stage in history and as something separate from the actual everyday workings of society because we can then think of radical ways of fixing or superseding it. But we don’t live in a world that is functionally destined to fall about our ears with predictable regularity. Crises do catch us unawares, and they happen in slightly different forms. John Maynard Keynes taught us (or should have, until most economists forgot him) that things can be done to regain full employment. Sometimes it’s good not to be shackled to ideas about the system.
Businesspeople shouldn’t run countries
Paul Krugman asks:
…why does anyone believe that success in business qualified someone to make economic policy?
For the fact is that running a business is nothing at all like making macro policy. The key point about macroeconomics is the pervasiveness of feedback loops due to the fact that workers are also consumers. No business sells a large fraction of its output to its own workers; even very small countries sell around two-thirds of their output to themselves, because that much is non-tradable services.
This makes a huge difference. A businessman can slash his workforce in half, produce about the same as before, and be considered a big success; an economy that does the same plunges into depression, and ends up not being able to sell its goods. Nothing in business experience prepares one for the paradox of thrift, or even the inflationary impact of increases in the money supply (which is real when the economy isn’t in a liquidity trap.)
(The paradox of thrift says that during recessions if everyone tries to save more then demand will fall, reducing consumption and economic growth and in turn lowering savings. The liquidity trap is the situation we’re probably in now — where further reductions in interest rates won’t raise economic growth.)
OK, Krugman’s argument is more relevant to the United States Republican party nominations, which seem like an alternate universe in which candidates by the day spew forth increasingly slavish support of business and mounting hatred of tax and the poor. But it applies to other countries too, where politics is seen as a technical discipline in which we ‘employ’ ‘experts’ to sort our problems out. Mario Monti’s technocratic Italy is a good example. He’ll probably do a good job of slashing spending because he doesn’t have to bother about his constituency or mandate, but he might not be good for Italy over the long run, and nobody voted for him.
The technocratic view forgets that democratic politics is supposed to be about what people want — schools, sports, the arts, nice lives — it’s not just about further pumping up the economic behemoth. And anyway the apparent technocrats — who mostly seem to have a background in business — aren’t good for everyone. Democracy is a better way of running things over the long term. Politicians who cater to everyone tend to recognise the complexities of the economy and society; that consumers are also producers, or that the poor will revolt if they’re left in the gutter for too long. It might be relatively straightforward to do the sorts of things that help business in the short term, like getting rid of welfare and spending less on schools, but 10 years later you’re left with a shell of a state and a pissed-off population. The examples of democratic success are numerous. Amartya Sen famously argued that India never had a famine after it threw the Brits out. Dani Rodrik pointed out that in Argentina fiscal austerity prompted voters to reject the ruling party: “democracy shoved the golden straitjacket aside”.
I also like Krugman’s reference to feedback loops, the pervasiveness of which is one reason why social science is different to natural science. Society, which is what politicians have to deal with, is a self-relating system which is far more complex than a company. It is this reflexivity which requires not narrow expertise from a particular side of the productive system, but a more nuanced, broad-ranging set of views, mandated by the different human beings who participate in that system.
US government debt isn’t the problem newspapers think it is
This is from Dean Baker at the Centre for Economic and Policy Research
The Post Disagrees With Financial Markets
Friday, 23 December 2011 06:26 In an article discussing House Speaker John Boehner’s performance in his job, the Post referred to his negotiations last summer with President Obama over, “the federal government’s swelling debt problem.” Newspapers interested in maintaining the separation between the news and opinion pages would have simple referred to the debate over raising the debt ceiling, which is what was at issue.
The debt has risen rapidly because of the recession that followed in the wake of the collapse of the housing bubble. Financial markets do not see the debt as a problem, which we know since they are willing to lend the government huge amounts of money at very low interest rates. There was no reason to interject this sort of editorial comment in a news story.
… the notion that we’re facing some kind of imminent threat from deficits isn’t based either on what the market is saying or on received economic theory. It is, when you come down to it, based on nothing more than a gut feeling that deficits must be a Bad Thing; and the people whose guts apparently get taken seriously have been wrong every step of the way.
And yet this more or less made-up notion of a debt crisis, which is in the end a prejudice rather than a reasoned conclusion, is reported as a fact in what is allegedly a news story, not an opinion piece.
I just read two stories from the end of 2007 just before the start of the financial crisis. The Torygraph like a number of other newspapers ran a story pointing out that personal debt for the first time exceeded GDP.
Stephen Gifford, chief economist at Grant Thornton, said: “Britain’s huge level of consumer debt is symptomatic of the country’s well-established ‘buy-now, pay-later’ culture. We can no longer generate enough yearly GDP to cover the amount we owe and need next year’s income to cover this year’s debts.”
Around the same time the BBC ran a story by Michael Blastland and Andrew Dilnot pooh-poohing the scaremongers. It’s true — there’s nothing sacrosanct about the 100% personal debt: GDP figure. It doesn’t really matter that the economy can’t generate enough wealth in a year to pay off personal debts because this isn’t something that’ll ever have to happen.
But the Beeb was wrong to suggest that “rising debts are an indication of rising ability to borrow, resulting from rising wealth”, because wealth itself is partly a function of debt. The inevitable deleveraging would weigh on the economy. One of the overall conclusions is that the rising number of bankruptcies “do not indicate a national crisis, and they do not show that debt is bad.” Correct, but the overall thrust of the argument couldn’t be more wrong, and the timing — October 2007 — is ironic, because it presaged the entire debt-driven collapse of lending markets which precipitated the crash and the great recession. A trillion dollars of debt does matter, and the country’s well-established ‘buy-now, pay-later’ culture is a problem, even if in a slightly different way to what Thornton suggested.
Steve Keen’s an economist worth listening to. In this video he explains how to sort the financial mess out. He thinks we should pay off private debt for people and companies, take the banks under government control and launch a financial system which made money available for business investment, not for gambling on house prices or stock markets.
It’d be difficult to untangle the different sorts of lending because they are so interconnected. Banks lend to each other using complex conconctions of debt as well as lending to companies and individuals. But the untangling’s got to be attempted because we have to distinguish between good lending, which finances productive investments, and bad lending, which is used to bet on rising asset prices. The build-up of a huge pile of bad debt got us into the crisis.
Another vital — and basic — distinction, which even the interviewer in the video appears to miss, is between private and public lending. In Britain private sector debt is about 450% of GDP, over triple what it was in 1987. Government debt is about 150%, having roughly doubled because of the bank bailout. Even after the bailout private debt is like Ben Nevis to private debt’s Carnethy.* And as shown by this graph from Anne Pettifor of PRIME, within the private sector financial companies accumulated by far the most debt over the past two decades.
Public borrowing has also jumped as a proportion of economic output in the last few years, but that’s partly because the private sector had so overextended itself that it slashed lending for investment, cutting economic growth. The British government is wrong to lay all the blame for the crisis on a bloated state. UK Chancellor George Osborne is worsening the crisis because he’s shrinking spending at the very time when the economy needs more help; and with interest rates very low he could cheaply borrow more to kickstart the economy.
Writing off debt would be a radical measure, not least because it’d be technically tricky. How to distinguish between good and bad lending? It’d be important to devise a way of requiring people and firms to pay off debt rather than spending the windfall and running up a new credit-card bill. Any new financial system would need some way of preventing future financial or property gambling. I think there should be a ban or punitive tax on house sales within five years of purchase, for example, like in some Swiss Cantons.
People would also grumble that a debt jubilee would punish the sensible and reward the reckless. We’d have to devise some systematic way of distinguishing between worthy and unworthy debtors, probably related to income. But at the moment we’re rewarding the reckless — the banks — by an order of magnitude. And as Keen points out the consequences of not paying down the debt could be catastrophic: years of slow economic growth, sustained high unemployment and possibly political backlash from unemployed youth.
Lastly, a note about credibility. Keen didn’t just pluck his arguments from thin air. Underlying his proposal is an important economic argument about how money’s created. Keen thinks that banks create money by lending. That free credit card thrust at you through the letterbox is a form of money-printing.
Most mainstream economists, on the other hand, believe that banks just mediate between savers and borrowers, receiving deposits from people and lending the money on to companies and taking a cut in the process. For Keen, banks are money machines. For most economists, they’re simply lubricants in the capitalist machine.
I think Keen’s right. The mainstream is a bit naive — it’s not as bad as imagining that cash grows on trees; maybe a bit more like pretending that money is found behind a bush. The Bank of England is full of mainstream thinkers who’ve got a mistaken idea about how money is made. That’s why their main policy for digging us out of the crisis — quantitative easing — is the wrong medicine. If you directly create cash in the current climate and hand it to the banks, they’ll hoard it rather than lend it to companies. If you comprehend that money is created in the very act of lending to the private sector, then you’re a lot further to understanding what’s really going on and you can design appropriate policies, ones that downsize silly lending, restore confidence and get the economy moving again.
Keen draws on Keynes, who has come back into vogue in the last few years (all the best economists have K, E and N in their surnames. What did Barbie’s other half do again?) Another of Keen’s heroes is Hyman Minsky, also in favour since the crisis. Both of these greats were renowned for being realistic about economics and not theorising as if they inhabited some alien planet. They struck at the roots of a problem without bothering much about convention. For me that’s what makes a good economist. Radical problems need radical solutions.
*hills in Scotland
All economic statistics are best seen as a peculiarly boring form of science fiction, but China’s numbers are more fictional than most.
Paul Krugman, New York Times 18 December 2011.
Last week the UN held an expert meeting in Mauritius on small island developing states aimed at better defining the category and proposing measures to help them.
SIDS are a special case. They’re not poorest countries in the world but their development options are limited. Their home markets are often miniscule and scattered. Many can’t easily export to bigger countries because they’re so far away. A lack of diversification makes them vulnerable to outside economic shocks. Natural disasters like hurricanes and tsunamis add to the uncertainty, and climate change means that several, like Tuvalu, are likely to suffer coastal erosion in years to come.
Any support from international donors and trading partners should reflect these special characteristics. One size doesn’t fit all, so good diagnosis is critical. Aid should be spent on trade-related technical assistance for SIDS, along the lines of the Enhanced Integrated Framework for Least Developed Countries.
The biggest unexploited area, in my view, is the internet. Lots of SIDS don’t have broadband or even affordable mobile phone access. It doesn’t matter whether you’re in New York or the middle of the Pacific, you can still do business online. Some commentators, like Nicholas Negroponte of MIT, have even argued that the future of international commerce is on the web. We’ll trade in bits, not things. SIDS might even be at an advantage because they’re not lumbered with natural resources like bigger mainland countries. Generally they’ve got higher levels of education so they can take advantage of internet opportunities.
SIDS also tend to have big communities offshore which could benefit their home countries in the form of remittances and the transfer of expertise and capital. The likes of Tonga, the Seychelles and Samoa, for example, have as many relatives living in developed countries as they have at home. The diaspora could be helped to contribute more to their home countries through things like tax breaks and other incentives.
Developed countries should also hand out more working visas to SIDS-dwellers. This shouldn’t alarm immigration-averse governments because it wouldn’t involve too many people. Labour mobility has been shown to be one of the best development interventions, far outperforming measures like microfinance or business grants.
More could be done to mitigate the problems of islands. The Caribbean has a disaster insurance system aimed at protecting against hurricanes. This should be extended to other small island states in the Indian ocean and Pacific. Trust funds like Tuvalu’s effectively function like an insurance system because they diversify risk across a number of countries.
Donors and development banks should also recognise that governments in SIDS need to be bigger than normal, reflecting the need for some government services to be duplicated on different islands in an archipelago and that in the absence of sizeable markets government simply has to perform a backstopping role. If a shop on a remote island closes, people can simply go hungry. There may be few incentives for the private sector to provide the service, and government may need to step in instead.
Doubtless many more things could be done to help SIDS. But now is a good time to try and do something about their problems, when attention is focused on climate change and developed countries appear more sensitive to the difficulties of nations on the global periphery.
Vanuatu joins the WTO
On 1 December Vanuatu’s parliament finally voted in favour of joining the World Trade Organisation, clearing the way for membership. Myself and colleagues worked hard on accession over the past decade, and i’m glad it’s finally happened. I’ve never been a passionate advocate or critic of the WTO in Vanuatu; I just thought the country should do what was right for itself based on good information, diagnosis and analysis. WTO membership won’t mean access to new markets since European and US markets are already open to Least Developed Countries. It won’t open up markets to new goods imports because protection can mostly remain at current levels. One of the main benefits is that it’ll give the country a seat at the negotiating table. It’s a sign of a maturing country, one which has developed fast in the last few years.
