The market is not capable of being rational,but people are

28 10 2009

images[1]The news that George Soros is creating and financing a new economic thinktank  called the Institute of New Economic Thinking (INET) should not be a surprise given both the destitution of modern economics and Soros’ own conviction that traditional economics is ‘a dogma whose time has passed’. As I have argued before there is little doubt that rational or free market theories have been discredited by the reality of the financial crisis, although this does not mean that we have really been living through a period of free market economics.

However, while a reassessment of the way forward for economics is way overdue, it seems unlikely, given its brief ,that this new Institute will help very much. For a start, as Anatole Kaletsky makes clear in the Times today, it will be heavily influenced by the Behavioural Economics school of thought. This rightly rejects the spurious rationality of mainstream economics but replaces it with a view based on the belief that people are basically irrational and the future unpredictable.

To gain a genuine understanding of unpredictable reality, some unorthodox economists may employ new mathematical techniques of non-linear dynamics and chaos theory. Others may revive the literary and anecdotal traditions of the great economists of the past, building on the work of sociologists, psychiatrists, historians and political scientists disdained by the present orthodoxy. INET will try to support these new schools of thought.

As I said in my review of a book by influential behavioural economists, 

We can agree with the BEs that the market, or capitalism, is not rational in the way that rational market theorists claim. The most singularly irrational aspect of capitalism is that decisions to invest are made by individual or groups of capitalists rather than by or in the interests of the majority of people. If the prospects for profitable investment look poor, because the expected rate of profit is too low or too risky, then money flows elsewhere. In the past ten years money flowed instead into apparently safe areas such as financial derivatives based on assets like housing etc . This created an unsustainable asset bubble which inevitably crashed and burned. Phil Mullan calls this the over financialisation of the western economies, the tendency for money to try to beget more money without going through the process of productive investment in new businesses.

Crises in the financial sector are an inevitable outcome of the over financialisation of western economies. The exact day when they will happen cannot be predicted, but the continuous instability and the tendency towards crisis contained within it will always remain. But it is not inevitable that we have to have economies of this sort. The danger of Behavioural Economics is that it condemns us to a future where the vagaries of the market are a given and the only question is how to manipulate and control the activities of the irrational people engaged within it.

Once we accept that human behaviour is irrational and the future unplannable and unpredictable then we have taken out what is unique about humanity, its ability to consciously and collectively organise and influence the future. One bright spot about the current recession is that it has revealed the bankruptcy of the prevailing economic orthodoxy. It would be a great shame if the vacuum thus created were to be filled by those who have the most disdain for human rationality. This weekend I and many others will be debating the future of the economy with experts such as Lord Skidelsky, Martin Wolf and Paul Mason at this event. Come and join us.

After the recession-the return of Keynes or the end of economics?

21 10 2009

images[1]Robert Lucas, the University of Chicago economist, joked last year that “everyone is a Keynesian in a foxhole’. At first glance it certainly seems that the idea of government intervention to maintain economies in trouble has made a comeback. In the past year various governments have nationalised banks, introduced major stimulus programmes, prevented industries from collapsing, subsidised employment and printed money in order to combat the financial crisis.

Yet as Sean Collins has argued in his excellent review of Keynes: The Return Of The Master by Robert Skidelsky, whom I shall be debating next week at  this event  , the ragbag of anti-crisis measures put together around the world was not the product of any widespread conversion to Keynesianism. It was instead an ad hoc programme of state measures aimed at one thing-staving off financial collapse and its perceived consequences.

The Keynes they like is not the proponent of permanent state intervention to guarantee full employment. He is instead the man who said ‘in the long run we are all dead’. In so far as Keynesianism means anything today it represents the short term managerial approach to running economies which characterises the UK and other developed countries. Why has there been so much state intervention from governments which have been arguing for ‘light touch’ regulation for the past ten years? Because there is no alternative on the horizon.

The recession has effectively destroyed, at least for the time being, the belief in free markets that has governed most of the developed world since the discrediting of Keynes in the 1970s. As Sean Collins argues however, we should not go along with the thesis that the past thirty years have been about actual free markets. During this period the state has continued to intervene in the economy, although in different ways.

Nevertheless we have reached a point where economics itself has been discredited. As Daniel Yergin argues there are so many explanations for the recession that no coherent narrative has emerged. This vacuum is being filled by another legacy from Keynes. His belief in both the power of psychology and the essential uncertainty of the capitalism economy have become more influential in response to the recession. Both of these points are highlighted by Skidelsky in his book.

The falling back on psychological explanations for the crisis amongst behavioural economists is a rejection of real economics. The crisis has in roots in economic stagnation in the west, the consequent financialisation of western economies and global imbalances created by the relative dynamism of the BRICs. To ignore these causes and point to crowd psychology reduces the problem to one susceptible by state manipulation of people’s activity. In this sense it fits with the short termism we spoke of above. It represents an inability to face reality and think through what it would mean to create more dynamic western economies.

The elevation of uncertainty as a major problem is also wrong. Keynes, writing in the 1930s was obsessed with the threat of capitalist collapse. Faced with the Depression and looming global conflict this was not an unreasonable fear. It is to Keynes’ credit, in contrast with many who followed after him, that he understood that economics is about politics. His argument for full employment was that it was necessary to stave off revolution.

In fact one thing the recession has shown us is that capitalism is in general very stable and quite predictable. We are in the midst of a major recession but as I have noted before there has been very little social response. This is because capitalism is at root a system of social relations. No matter how bad the economy may get, as long as there is no organised alternative it will bounce back.

Emphasising the uncertainty and risks involved in capitalism today can only have one effect, one which Skidelsky himself recognises,’uncertainty imposes a kind of permanent fearfulness about the future which puts a damper on economic progress’. Skidelsky also criticises some of the behaviouralist economists, like Shiller, for ‘panic’ in the face of apparently irrational human behaviour in the run up to the recession.

There may be opportunities, due to the crisis within economics, to debate what kind of economy we need. This would entail rejecting the panic and uncertainty brigade and arguing for a longer term more strategic approach to the economy, more planning, more debate about where we want to go and above all more leadership.

Mandelson’s ‘industrial activism’ to boost innovation-too little too late

14 10 2009

images[3]I am finding it increasingly difficult not to like Peter. He is a key fixer in a long tradition of manipulative politicians going back to Francis Walsingham under Elizabeth the First. There is an element of pantomime about him, somebody the public likes to boo or hiss when he appears on the stage. He has chosen to throw his weight behind the project to stop Labour sinking without trace. There is something quixotic and admirable about this, whatever one thinks of Labour.

 Listening to him speak at this event yesterday it became clear that he is converted to a policy of ‘industrial activism’, that is the government taking a leading role in the nurturing and development of innovation and investement. This new initiative on bioscience looks on the surface like a good idea. It is important for the state to use its resources and authority to enable economic development as I have argued before on these pages.

The problem with Labour’s  current attempts to move from financial to real engineering is that they are too little too late. The sums of money being made available by the state for assistance to new businesses and innovation are tiny relative to the scale of the problem. Nor is this just a problem at the  state level. As a society the UK has little appetite for risk. As Mandelson pointed out in his speech, investment in research and development in the UK is lower than for many of the UK’s competitors.

Labour has come late to industrial activism. For most of the past twelve years the main focus of government activity has been on boosting spending on health and education. This extra spending was financed largely by the expansion of financial services and an increase in debt, in other words through spending the money that Chinese people have been earning.

At least in part, the focus on health and education was in response to market research which indicated that these were the areas that people in the UK were most concerned about. It is all very well for governments to respond to the wishes of its electorate. To some extent this is both inevitable and desirable. However there is another part of government responsibility which Labour has largely evaded, that of leadership. There are key areas of the UK economy which have required investment and support, such as nuclear power stations, better roads, investment in GM and other new technologies, which the government backed off from because they were unpopular. Rather than trying to win the arguments for these various key projects the government caved in, often ordering lengthy inquiries and further tests rather than risk making itself unpopular.

The Stevenage bioscience project which Mandelson announced yesterday is aimed at boosting the development of the UK’s drug industry. Yet the pharmaceutical industry has been vilified over the years in many quarters and its products, such as the MMR vaccine, held up as public dangers. When Blair was confronted with this vilification he famously declined to say whether he would give his son the MMR vaccine, thus encouraging those who irrationally opposed its use.

The UK government going forward has to take a more activist role in planning the shape of the UK economy. Its role has to encompass persuasion and leadership to convince an often sceptical public of the long term benefits of innovation in energy, technology and science.

Does debt matter? Why the Tories are ‘sending a message’

8 10 2009

images1The British political classes are going through one of their occasional bouts of masochism, with party leaders vying with each other on the theme of who can cut public spending faster and more effectively. Spice is added by talk of leaks and secret plans; and ideology by arguing about the balance between tax increases and spending curbs. My own bottom line is that all this is in response to a largely imaginary budget crisis. If we have a normal economic recovery the red ink will diminish remarkably quickly.  Samuel Brittain

Samuel Brittain’s article hits the nail on the head when it comes to the debt question. The UK’s debt is only a problem if you do not believe that the economy can grow its way out of the present recession. Behind the current competition amongst the political parties to be the most bloodthirsty cutters of public expenditure lies the same fear, that the UK cannot become a serious growth economy again.

Tory Shadow Chancellor George Osborne has spoken of the need to regain the confidence of international investors and credit agencies, saying  ‘it was a “statement of facts” that three agencies, Moody’s, Fitch and Standard & Poor’s, had all voiced concerns about Britain’s ability to pay off its record debts.’ If Osborne’s intention is to really cut the UK’s debt then the measures announced so far will hardly affect it. They amount to a saving of only £23bn out of a deficit which will be closer to £200bn. While recognising that his proposals will not solve the debt problem Osborne claims it is necessary to show credit agencies  that the UK is ‘deadly serious ‘ about tackling its debt.

In other words Osborne is ‘sending a message’ to the world in classic New Labour fashion, rather than making efforts to tackle the real problem, which is the expected low growth economy we will have in the UK. In fact Osborne’s speech was almost entirely lacking in any proposed measures to create new areas of growth in the UK economy.

In the absence of plans for growth Osborne can only offer austerity. His way of expressing this  in his speech to the Tory Conference was to appeal to a shared need to accept cuts in living standards. Hence his repeated assertion that ‘we are all in this together’. The Tories have no doubt been encouraged by the lack of any social response to the recession. They must believe that people here are willing to accept real cuts in living standards over the next few years.

Yet there are reasons to think that they may be deluded if they believe that they can push through an austerity programme very easily. Firstly, for most people in the UK the recession has been so far relatively pain free. While those losing their jobs have been hit hard, many of those still working have benefited from zero inflation, low interest rates and cuts in prices of many essential goods. There is little evidence that people have so far embraced austerity.

Secondly most people feel deeply alienated from the political class. The MPs’ expenses affair was an expression of this. The Tories, if they form the next government, may find it very hard to mobilise support for unpopular measures.

Will this be a jobless recovery?

6 10 2009


AUAFSC9CA3B1FKFCA8XU5EPCA777ZTDCAR59Y2VCASIJMODCALGU5QUCAMXXSGBCAB6JSZRCA8KMPKXCARPYO9JCA653CVZCA0PX1P5CAW6HNUCCAVKPXI4CA0ILQW3CA370OV9CA9IHIE3CA7MSGYCCAVC85EWBetween 1999 and 2007 manufacturing jobs in the UK fell from 4.5m to 3.3m. In the same period jobs in the financial and business services sector grew from 5.3m to 6.5 m, and jobs in the public sector grew from 8.4m to 9.9 m. The Financial Times claims that around two thirds of jobs created since 1998 have been in the public sector. Most strikingly, within that figure, of the 1.07 m jobs created in the public sector,963,000 were taken by women in health, education, social care and social administration. There are at least 10 areas of the UK, all outside London, where 40% or more of those working are in the public sector. 1

There is good reason to fear that whatever the eventual shape of the UK recovery it will not bring with it many new jobs. As a result we may have to live with a much higher level of structural unemployment than has been the case for the past ten years. The two main areas of job growth in the UK in the past ten years were across the public sector, particularly in welfare and education, and in financial and business services. None of these sectors is likely to play the same role in the next ten years, if for different reasons.

The public sector now looks as if it will be, if not necessarily cut back as severely as the bloodthirsty rhetoric might suggest, then at least contained. Financial and business services may stabilise but are unlikely to regain the dynamic growth of the boom years.

Neither is the long term decline in manufacturing jobs likely to be reversed. The UK’s role in manufacturing is predominantly in areas of high productivity with high skill levels. Even with more investment and more support and encouragement from government, which would be very welcome,  manufacturing is unlikely to add a huge amount of new jobs.

Both the Tories and Labour are proposing ways of trying to reduce unemployment, but these are mainly on the supply side, through for example attempts to get people off of sickness benefit. Forcing people back to work only makes sense if jobs are available for them to do, and at decent wages. The main effect otherwise is the traditional role of the unemployed as the reserve army of labour which helps to force down the wages of those in work.

The proposed extension of the retirement age to 66, although welcome for other reasons, will also have the effect in the medium term of adding to the ranks of the unemployed, particularly the young.

Unemployment is now nearing 8% of the adult population of working age. It is estimated that it will reach at least 3 million by next year. With benefits also likely to be squeezed this means misery for millions. This is the reality of the austerity plans both parties have in store for us.  Far more discussion is needed  about what kind of economy the UK could have which could gainfully employ the unemployed.










After the recession-winners and losers

1 10 2009

ADR1SLKCAA3BDO3CAMR91MACAMICXACCAOCEYP1CAI1LJ91CA1T3JB8CACGBU4ECAW3UOYUCA4MN4QRCAFGIPYCCA5TT2W7CARIKEBXCABLGWTJCAR6GX1ICAU81D48CA175TUFCALF0KX9CAQRNIRKCAN99ILOEvery economic crisis creates its own winners and losers. At the level of any domestic economy a recession is often the last straw for an outmoded business, sometimes even whole industries can be swept away. This recession looks as if it might deal a grievous blow to the printed newspaper business as advertising revenue has dwindled. In the UK online advertising spend has overtaken tv advertising for the first time. The main benficiary in each of these cases case has been the digital industry and so the recession acts as a midwife to change. Such developments as these are seldom reversed.

It is important to remember that recessions only speed up developments which are already under way. We are only at the beginning of the process of change hastened by this recession. In fact, many of the actions taken by western governments have been attempts to prevent change, the propping up of the US car industry by the Obama regime being one example. It is also possible that western governments saving banks from bankruptcy may turn out to be a mistake in the longer term. As the IMF has pointed out, the empty hole at the centre of the financial system created by toxic debt has been painted over, not filled in. Trouble has been stored up for the future.

At a global level we can now also see how the recession has revealed a changing balance of power. The credit crunch has laid bare the dependence of the US economy on finance from China and other nations. It has also shown how undynamic most western economies currently are compared with these emerging nations. The emergence of the G20 as a body of international governance is an expression of these changes.

The UK is now in danger of being left behind. It appears increasingly marginalised from both its Atlantic and European allies. There is a measure of incompetence in the way foreign policy relations have been handled, for example over the Lockerbie affair which has annoyed the US. But the UK’s problems are based in the relative decline of its economy. It is  overdependent on the financial sector and an absence of any Plan B now that this source of growth has been threatened has created a biq question mark over its future. The movement of the headquarters of HSBC from London to Hong Kong may well be a straw in the wind, expressing both a shift  away from the UK as a leading financial centre and towards China and the east as its replacement.

The announcement of a new Franco German pact is a sign that the UK is seen as outside the mainstream of European developments. The UK faces a public spending deficit which threatens its  ability to stay at the top table internationally. Already Trident is being questioned and the UK’s willingness and ability to participate as a US ally in foreign wars is also being potentially undermined.

Does the UK’s relative decline matter? If other parts of the world are becoming more economically dynamic does it matter if this one part of it is in decline? Obviously it matters to us as citizens of this country if our living standards are to deteriorate. But I think there is also a greater issue at stake. Currently the most dynamic economies in the world are the least democratic. Perhaps this will change, perhaps it will not. Here in the UK we should recognise that the survival of democracy and its extension depend upon continued economic progress. A declining and stagnant economy tends to foster a declining and stagnant democracy.