A thoughtful paper in the Journal of Institutional Economics by Philip Mirowski argues against the personalisation of the global economic crisis and disputes the notion that government policy was entirely to blame.
According to some accounts, the likes of Bernie Madoff and AIG’s Joe Cassano caused the entire calamity themselves, flanked by the crony capitalists who stalked Wall Street. A few bad men infected the entire system. In a similarly individualist vein, Tyler Cowen said that Americans didn’t save enough and had taken on too much risk due to ‘investor hubris and collective delusion’. A bit of bad luck combined with poor governance to sink the economy.
These sort of explanations are ridiculously superficial. Of course a handful of men couldn’t have caused the entire crisis. Greedy people have always existed, and their influence varies at different times. Low savings rates and an appetitie for risk had an impact, but they aren’t anything like the whole explanation behind the crisis, and they can’t be seen in isolation, without looking for more profound causes.
Only slightly better than individualistic explanations of the crisis are those that fault government – mostly, a lack of regulation. As examples of this argument Mirowski lists the repeal of Glass Steagall (which separated retail from investment banking) in the US in 1999; the refusal to regulate credit swaps; the revision of the net capital rule by the Securities and Exchange Commission; and the enshrinement of ‘market discipline’ for international banks through the Basel II accords.
Other commentators blame bad regulation. The US government reduced the quality of mortgages through the Community Reinvestment Act and political pressure on Fannie Mae. Many argued that the Greenspan Fed kept interest rates too low in the new millennium, helped by capital from China and cheap consumer goods.
But the strength of institutionalist economics is that it looks for deeper causes, examining, for example, the structures in which bad men existed and why people saved so little. For Mirowski even the government failure approach doesn’t cut it.
Since the crisis, Hyman Minsky has become the poster-boy for institutionalists and others. He put forward a model which predicted that periods of long boom would make the economy more and more complex, almost inevitably causing it to collapse. The system is inherently unstable because markets tend to undermine themselves.
For Mirowski, the problem with Minsky’s approach is that it only has one measure of complexity, the leverage in the entire macroeconomy (specifically it is the relative proportions of business current obligations paid out of current income, balance sheet manipulations and portfolio alterations in a given time period).
Minsky needs microfoundations. After considering a number of possibilities, Mirowski settles on the answer that the economy has ‘inherent vice’. He goes on to describe some quite complicated notions of computational complexity in an effort to flesh out these microfoundations. Essentially he is arguing that leverage isn’t enough to measure complexity, and that studying the interaction of automata – what he calls markomata – can help explain the tendency of markets toward bubbles.
My main response to Mirowski’s paper is twofold. First, not all institutionalists entirely discount the government failure model. Whilst it’s a good idea to look at the deeper causes of the crisis, government behaviour was itself partly a product of structural changes in the economy. The massive accumulation of global debt since the 1980s was a result of Minsky-type phenomena, under which financiers relentlessly expanded credit. The long boom and the increasing complexity of market transactions subsequently encouraged government to relax regulation: to repeal Glass Steagall and to refuse to regulate credit default swaps. Government failure was a key mechanism through which the Minsky model operated.
I’m sure Mirowski is aware of this connection, but it seems wrong to dismiss the government failure model entirely. Governments were, partly, to blame.
Second, I’m not sure the level of computational complexity discussed by Mirowski is entirely necessary; or at least that the specific microfoundations suggested here are permanently valid. I don’t quite see the point of concentrating so much on computational behaviour. Whatever the manifestation of the crisis, it’s the underlying explanation that matters, not the form that the complexity takes.
Anyway, the paper is a good example of institutional economics in action. It rightly exposes the personalization of the crisis as myth. It moves beyond blaming government for everything, and it reasserts the importance of Minsky, rightly suggesting that we need a better measure of complexity. I’m just not sure that it settles on the right one.