Why the behavioural economists are wrong, a review of ‘Animal Spirits’ (Part Two)

1 07 2009
  
Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Rober Shiller

Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Robert Shiller

BOOK REVIEW (Part Two)
Animal Spirits: How human psychology drives the economy and why it matters for global capitalism, by George Akerlof and Robert Shiller (published by Princeton University Press)

“Animal spirits…is an economic term, referring to a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity or uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energises us, overcoming our fears and indecisions.” [1]

The first part of this review contested  Shiller and Akerlof’s claims that the recession is caused by the irrational behaviour of individuals. There is however much more in their book to challenge.

I once talked to a behavioural psychologist whose job was to improve the behaviour of children in the classroom. The first thing he told me was that to do his job properly he had to completely ignore the, often tragic, social backgrounds of the disturbed children. Instead, he focussed entirely on strategies for changing their behaviour by psychological tricks which were akin to those used to train dogs. I was reminded of this when reading Shiller and Akerlof’s approach to some major economic and social issues. They too ignore the historical and social factors which have led to many of the phenomena they discuss and instead present them as merely behavioural oddities.

Their view is that human economic behaviour is determined by a combination of five things: confidence, fairness, corruption, money illusion, and storytelling.

These are all relatively straightforward concepts, except perhaps for money illusion. Money illusion is a term used to explain why people will oppose wage cuts, even if the prices of what they buy are falling in deflationary times, more than they will fight for wage rises at a time of inflation when everything is getting more expensive.

Why do workers resist wage cuts and not fight as strongly for indexed linked rises?  Rather than a psychological reason, is it not more likely that workers understand that once they have conceded the need to accept pay cuts that they will have handed power to their bosses to do so again, to keep coming to the well? Is it not also likely that compared with this, the need to combat inflation, a future event which like all future events is uncertain, will seem less of a vital issue? The authors approach to this is typical of many of the points they make. They persistently choose to interpret attitudes arising from social and historical experience as hard wired psychology. Often this leads to observations which are so stunningly banal that you are left wondering whether these authors simply need to get out more. Take the following examples:

‘people rarely quit their jobs in recessions’[2]

‘people tend to want to work in higher paid industries’[3]

‘students…really don’t seem to care how much they save’ [4]

Their emphasis on the importance of storytelling also takes them away from understanding what is perfectly clear and rational behaviour based upon experience. They claim that the high savings rate in China and other new economies is down to the ‘story’ that ‘there is no shame in being poor in China, since this is viewed as a transitional state’[5], therefore people do not consume. However as many people have pointed out, in a country with often rudimentary social and medical insurance[6], savings are an essential to fall back on when times get tough.

The answer to most of the problems the authors riase is state action of one kind or another. For example, a discussion on racial discrimination in the US describes the situation of black Americans thus,

‘there is the notion among both blacks and whites that there are two groups, we and they. This very notion is part of daily reality. This notion – as much as low financial assets and skill levels – is responsible for the continued poverty of African Americans.’[7]

The experience of racism in the US is reduced to a ‘story’ which reinforces social stereotyping. The authors do not recognise that racism, where it exists, needs to be combatted through political means. Their suggestion instead is positive discrimination, action by the state.

Of course, there are many aspects of human behaviour which appear to be irrational. We can usually see them more clearly when we look at other people’s cultures rather than our own; and there’s the clue. Generally speaking these types of behaviour are the product of a specific cultural and social experience. Sometimes it is also true that we take our lead from what other people do, as in buying houses or shares in a rising market. But this is a perfectly rational thing to do in the absence of information as to why this is a bad idea.  Very few people can call the top or the bottom of any market, and those that do are often just lucky. In the mean time we all try to take as much advantage of it as we can.

The rise of behavioural economics is a symptom of the paucity of proper historical, political and economic analysis of society. In that sense it is just as much part of the voodoo culture of the day as the types of behaviour it disparages.

 

[1] Animal Spirits p4

[2] Ibid p103

[3] Ibid p103

[4] Ibid p116

[5] Ibid p128


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Why the behavioural economists are wrong, a review of ‘Animal Spirits’ (Part One)

24 06 2009
 

Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Rober Shiller

Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Robert Shiller

BOOK REVIEW (Part One)
Animal Spirits: How human psychology drives the economy and why it matters for global capitalism, by George Akerlof and Robert Shiller (published by Princeton University Press)

 

“Keynes appreciated that most economic activity results from rational economic motivations-but also that much economic activity is governed by animal spirits. People have non-economic motives. And they are not always rational in pursuit of their economic interests. In Keynes’ view these animal spirits are the main cause for why the economy fluctuates as it does.” [1]

One of the most frustrating aspects of the recession has been the absence of serious examination of its causes. Of course, there has been huge coverage of the events of the recession. But at the level of serious analysis there has been a dearth of proper public discussion. The political and public domain has been dominated by trivia such as bankers’ salaries or MPs’ expenses. Public debates have been restricted because there are few people who are able to discuss the economy and politics in the same breath. Yet it is impossible to make sense of one without the other.

The demise of politics and the political sphere as a meaningful forum for discussing the economy has encouraged the search for other explanations, outside the sphere of politics or traditional economics. Some people, including influential people within the Conservative Party in the UK, have turned instead to the behavioural economists (BEs), like Robert Shiller and George Akerlof, for explanations and guidance. Shiller and Akerlof’s case is that it is the behaviour of individuals within the market system and their psychology which explains much of what has gone wrong.

 Behavioural economists reject the view that the recession can be explained in traditional economic terms. In particular they have in their sights the rational market theorists, more commonly known as the free market proponents who have been influential since the time of Thatcher and Reagan, who argue that free markets can regulate themselves.  The upheavals of the past two years in the world economy have discredited the rational market theorists, as the blame for the recession has fallen on to the unregulated  nature of the financial markets. The BEs conclusion is that markets are susceptible to the irrational behaviour of individuals. This irrational behaviour requires state intervention to counteract it and to reintroduce stability. In the wake of the global recession this explanation and remedy is falling on fertile ground.

But the recession is not a crisis inflicted on an otherwise stable system by the behaviour of irrational individuals, as ‘Animal Spirits’ suggests. The problems of present day capitalism are the product of historical and economic developments within the system itself. The idea that anybody can say, as Gordon Brown did, that we can have neither boom nor bust, is plain wrong. The recession is just as intrinsic to modern capitalism as the boom which preceded it.

Whether it is the overdependence of the UK on financial services and public spending, the lack of any underlying productive dynamic to western economies in general, the crisis of the political class and its impact on the economy or the likely effects of the rise of China, none of these developments are explained or accounted for by Akerlof and Shiller. Their argument is that capitalism can work fine if it only had a little more regulation:

Capitalism can give us the best of all possible worlds, but it does so only on a playing field where the government sets the rules and acts as a referee.[2]

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 [3] calls this the 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.

In addition, capitalism is less and less able to stand on its own two feet as it becomes more and more established. The state often has to step in to try to prop up ailing industries, as the US government recently did with General Motors, or to subsidise whole ones, as the EU does with farming. The growth of financialisation and state support together represent the throttling of dynamic economic development in the west. The truly dynamic parts of the world economy are now in the east.

The approach to explaining the recession taken by the BEs turns reality on its head. Capitalism as a system with inbuilt tendency to crisis is let off the hook and the individuals who suffer from the recession are blamed for it.

Part two of this review will follow shortly

 


[1] Animal Spirits p ix

[2] Ibid p173

[3] http://www.spiked-online.com/index.php/site/article/4244/

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Oh no, not Keynes again! New economic thinking urgently required

26 04 2010

Book Review

The Economic Crisis and the State of Economics Edited by Robert Skidelsky and Christian Westerlind Wigstrom, Palgrave Macmillan, 2010

The Institute for New Economic Thinking, funded by the billionaire George Soros, held its first Conference in early April 2010. Just in case we were not already aware of its intellectual underpinning, the event took place at Kings College, Cambridge, where Keynes developed his General Theory, sessions took place in the Keynes lecture theatre and many of the participants and speakers were neo Keynesians.

Much of the substance of the discussion that took place is prefigured in a new book of essays, The Economic Crisis and the State of Economics, edited by leading Keynesian Robert Skidelsky. Although written last year in response to the recession, its themes have now become central to the range of economists lined up in Soros’s new Institute. The three main themes which emerge from the selection of essays in the book are, first, the future is uncertain and cannot be predicted, secondly, no economic model can be trusted to work and thirdly, economics cannot be a science because it is driven by often irrational human behaviours. A fourth, although often tacit conclusion, is that the state has to be prepared to intervene in order to make up for the inadequacies of the market.

The main target of the essays is the Efficient Market Hypothesis (EMH), associated with the Chicago school of economists, the view that markets operate efficiently and that state intervention can only be damaging to the market mechanism by distorting market rationality. The general view expressed in this book is that the financial crisis has destroyed both the practical and intellectual basis for the EMH. The peculiar aspect of this debate is that, although it is true that the EMH has been popular amongst some economists in the past, it has had very little to do with the real world outside of academia. In the real world the 20th century saw ever increasing state involvement in the economy at every level.

The free market, outside of state control, subsidy and regulation, is a myth. In that sense the EMH is a straw man for the Keynesians to tilt at. If you have any doubt about the irrelevance of the EMH in the real world then just look at how the world’s leaders responded to the financial crisis. Governments everywhere stepped in with massive subsidies to keep the financial system afloat. Would leaders who were supposedly ideologically wedded to the principles of the free market have acted in such a concerted way to bail out the markets?

Economics and rationality

So if the demolition job on the EMH is of little value, is there any interest in what the Keynesians are saying? Yes, because what they are trying to do is to suggest that rationality is not possible in the economic sphere. John Kay, in his essay, Knowledge in Economics, says that ‘the test of an economic theory is whether it is useful rather than whether it is true’. P91 Paul Davidson, in Risk and Uncertainty, says that believers in the EMH, and indeed anybody who accepts the views of the classical economists Smith and Ricardo, are guilty of thinking that ‘the future is merely probabilistically risky but not uncertain’ P20. Davidson argues that the future is not predictable and therefore planning is pointless. All governments can do is be prepared to step in when things go wrong, which they inevitably will.

The Keynesians are expressing in their abandonment of rationality the viewpoint of those who feel that the world is out of control. Paradoxically perhaps there is a rational aspect to this viewpoint. The global market is indeed out of control, but only in the sense that markets always are and always have been. Markets are the antithesis of rational planning. It is only after production has taken place, money spent and resources used up, that you take the product to market and find out if there is a buyer. Enormous effort and time is wasted on products which turn out to have no buyer, leading to waste, bankruptcy and redundancy. That is how the market regulates the economy, through destruction.

It is because of the essential irrational nature of markets that the state has emerged over a long period to regulate and support the economy and limit the damage done to society as a whole when markets cease to function effectively. The challenge facing us all, especially in the aftermath of the global recession, is to work out what a more rational economic world would look like and how it would operate. After all, most production is essentially rational, in that it is about the meeting of human needs in one sphere or another and requires conscious activity in order to be effective. The key element that is missing, which the Keynesians recognise, is the absence of enough information about what is happening in the economy which would enable people to make rational decisions. But that is not a problem of economics but of politics.

How can we organise an economy in which people are sufficiently engaged in and have control over the consequences of investment decisions and their outcomes? This would be a good subject for the Institute for New Economic Thinking to consider.





Resources

6 05 2009

Below are some articles, videos, websites, and events I refer to in my blog. 

 

ARTICLES and BOOKS to read

Books

Fixing Global Finance: How to Curb Financial Crises in the 21st Century by Martin WolfFixing Global Finance: How to Curb Financial Crises in the 21st Century by Martin Wolf (published by Yale University Press)  Read my review

 

 

Energise!

Energise! by James Woudhuysen & Joe Kaplinsky (published by Beautiful Books Ltd.) Read a review

 

 

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Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism  

by George Akerlof and Robert Shiller (Published by Princeton University Press) read my review here and here

Articles

In science, the bizarre is our insurance for the future by Anjana Ahuja

What would you pay for 400,000 new green jobs? by Ben Pile  

UK economy after the recession by Rob Killick (the UK after the recession)

Contriving Against Reality: the G20 summit and the empty shell of ExCel by Andrew Calcutt (the impact of the credit crunch on London)

The Great Crash, 2008: A Geopolitical Setback for the West by Roger C. Altman (why the West is losing the recession)

The Crunch and the Crisis: the unravelling of lifestyle capitalism?  by Gavin Poynter (the crisis of consumer capitalism)

 

VIDEOS to watch

G20 protests and contemplating on the G20 summit, London 2009

This excellent video charts the mood of the G20 protests that took place before the summit, in London and includes an interview with Rob Killick on some of the key political and economic issues we must grapple with in the face of the current recession and in the years to come – what the leaders in the G20 summit had very little to say on!

EVENTS to attend

Building Digital Britain 

WEBSITES to take a look at

 www.spiked-online.com





After the recession, a New World Order?

27 04 2009
<I>Fixing Global Finance: How to Curb Financial Crises in the 21st Century </> by Martin Wolf

Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf

BOOK REVIEW
Fixing Global Finance: How to Curb Financial Crises in the 21st Century, by Martin Wolf (published by Yale University Press)

Following the ‘credit crunch’ and now the full-blown recession, the big story of the twenty-first century is likely to be the shift in the balance of power between the indebted West and the credited East.  There are some writers on the economy who seem to understand better than others that politics should be seen as concentrated economics. Martin Wolf, associate editor of the Financial Times, is one such writer.

His FT column is a must-read for anyone who wants to understand what is happening in the current economic crisis. His latest book is about the problems of the world financial system and the events that led up to the current debacle. In it, Wolf explains both the underlying causes of the recession while also exposing the complex and potentially dangerous political consequences that have arisen as a result.

The central point in the book is that China is now playing a role in the world economy that no country has ever done before. China is ‘both the largest exporter of capital (as the United Kingdom was in the late nineteenth century) and the fastest growing emerging giant (the role played by the United States at that time)’.

China, along with other dynamic exporting nations, such as Japan, built up massive external surpluses of money in the period after 1997. The surpluses were based on the export of manufactured goods to mainly Western countries. By 2006, says Wolf, ‘The total Asian surplus was $511billion ($239billion for China, $170billion for Japan, and $102billion for the rest of Asia). The surplus of the oil exporters was another $396billion… But the US deficit was $857billion.’

So the US deficit was the equivalent of the total surplus of Asia and the oil-exporting countries. As a result, ‘The United States has in turn, been absorbing about 70 per cent of the surplus savings in the rest of the world, with the difference accounted for, not by increased investments, but by higher consumption and a lower rate of savings.’

Wolf is highly critical of the US for consuming rather than investing the massive amounts of imported capital, which ended up inflating the housing bubble and presaged the credit crunch. He sees the problem as one of underconsumption within China and other developing countries. He attributes the running up of huge external surpluses by China and others as a policy response to the Asian crisis of 1997/1998 when currencies collapsed and there were devastating consequences for the economies of some East Asian countries. He argues that ‘The lesson learned by many emerging economies – both those directly affected by the crises and those who have been onlookers – is not to tolerate current account deficits’.

So he sees the growth of external surpluses as a policy decision by developing countries. Others have argued that it is not as straightforward as that (1). China in particular would struggle to reinvest its huge surpluses internally because of the general underdevelopment of huge parts of the country (although its huge internal fiscal stimulus this year is trying to address that problem).

Wolf discusses why China and others have put huge sums of money into the US when the rate of return is so low. Given the problems China has in developing its own economy, the question really should be: what was the alternative, other than keeping the money under the bed? The nightmare scenario now for the Chinese is that the US inflates its way out of its debt, thus reducing the value of Chinese capital in the US.

So while we can understand from the Chinese point of view how we have got to where we are, from the US point of view the problem is completely different. The US and other Western countries, like the UK, have run up massive debts because, as Wolf points out ‘The high income countries have become importers of savings since their savings rates have fallen below their investment rates’.

Quite simply, we in the US and the UK have taken the savings from developing countries and consumed them, leaving ourselves in massive debt. The key question that comes out of this is how this imbalance in the world economy can be righted. As Wolf says: ‘A large-scale flow of capital from poor countries to the world’s richest nations is perverse.’

One consequence of the recession is that the international flow of capital has collapsed. It seems unlikely that, once the recession is over, the flows of capital from East to West will return in the same way. A rebalancing of some sort will have to take place. The West is unlikely to be able to resume its consumption of the savings glut from the rest of the world, certainly to the extent that it has in recent years. Western countries will have to find other ways to finance growth and consumption while we can assume that developing countries will shift their surpluses more towards the development of internal markets.

The rebalancing of the world’s economies will also, of necessity, affect the way the world is managed politically. Currently all of the world’s financial and political global institutions reflect the relative economic weight of countries 40 or 50 years ago. This will have to change. This is where it becomes politically challenging. As Roger Alton has pointed out:

‘The financial and economic crash of 2008, the worst in over 75 years, is a major geopolitical setback for the United States and Europe. Over the medium term, Washington and European governments will have neither the resources nor the economic credibility to play the role in global affairs that they otherwise would have played. These weaknesses will eventually be repaired, but in the interim, they will accelerate trends that are shifting the world’s centre of gravity away from the United States.’ (2)

As a result, some countries will lose power and influence and others will gain. Whether and how this can be managed is going to be the story of the first part of the twenty-first. Managing this shift in the middle of a recession is a huge political task, to which Wolf offers no solution except to argue for a restructuring of the International Monetary Fund. Nevertheless, he has written a fine account of the economic issues underlying the political problems facing the world today.

This book review was published by www.spiked-online.com on 23 April 2009

(1) See Darling, it’s all about the global imbalances, by Stuart Simpson.

(2) The Great Crash, 2008: A Geopolitical Setback for the West, Foreign Affairs, January/February 2009





Selfish Whining Monkeys

16 07 2014

thCAHVFC1Z
Selfish Whining Monkeys by journalist Rod Liddle has had a good duffing-up by reviewers and commentators. Some of his harshest critics are, unsurprisingly, the sort of people Liddle blames in his book for many of the ills of modern life. David Aaronovitch, Will Self and Julie Burchill are among those who have lined up to put the boot in.

Why has Selfish Whining Monkeys, which, in style and content, is very much like Liddle’s popular column in The Sunday Times, had such a hostile response? Liddle could see this as proof that he has hit his target, as most of the hostile reviewers are part of what he characterises as the ‘faux left’, the metropolitan elite who ‘consider themselves left, or leftish, but whose views are either wholly irrelevant to the poorest indigenous sections of our society, or positively hostile towards them’.

And there you have the nub of why Self et al have attacked this book so viciously. The claim against Liddle is that his championing of the white working class, his opposition to immigration and his nostalgia for an overwhelmingly white, prelapsarian 1950s Britain (Liddle cites the decline of organised religion as one of the reasons for our current social malaise) automatically make him a racist. The critics do not prove this claim, preferring, as Aaronovitch does, to notice ‘the sly references to racial characteristics’. Self is subtle enough to suggest that Liddle may be suffering from a kind of false consciousness, that Liddle ‘thinks he believes’ he is not a racist but really he is, as evidenced by his use of words such as ‘tribe’ to describe the Muslim community.

If this sounds familiar it is because it is the same charge that has been made against the UK Independence Party (UKIP) and its supporters over the past year. In many ways, Selfish Whining Monkeys could be a manifesto for UKIP. Each chapter is its own furious polemic against an aspect of modern life – schools, the class system, the aforementioned faux left, the EU, the free market, London. Like UKIP, Liddle professes to give a voice to those who have been disenfranchised by the congelation of political life into a ‘New Establishment’. In his column for The Times, Hugo Rifkind helpfully summed up what this New Establishment stands for:

‘I find myself perhaps belatedly realising, I am a man of strong establishment views. I am broadly Europhile and certainly unionist. That’s only half of it, though. I am also politically correct, feminist, environmentalist and avowedly multiculturalist. It’s a bit of a shock to realise these are all now establishment views; they certainly never used to be.’
Liddle’s crime, in the eyes of the New Establishment, is to claim to speak for those who feel they have been left behind by modern life. These days, as we saw with the media’s relentless campaign against UKIP leader Nigel Farage, this is enough to turn him into a pariah.

But his book is more than a simple Farage-style saloon-bar rant. Like his columns, it is also often very funny, self-deprecating and quick to notice the absurdities of modern life. He reflects on the aftermath of his Spectator column, ‘Dr Liddle’s Casebook’, in which he panned the claims that ME is a physical disease. Among those who wanted him prosecuted for hate crimes against ME sufferers was a woman who, Liddle recounts, was told by police ‘that the man [Liddle] was a well-known arsehole and it was best to ignore him’. ‘So common sense still exists in at least one constabulary, then’, is Liddle’s witty aside.

Liddle’s crime, in the eyes of the New Establishment, is to claim to speak for those who feel they have been left behind by modern life. He also picks up on other, less populist aspects of modern life which he finds distressing, such as the intrusion of the judiciary into political life, the rise of censorship and intolerance (he defends Muslims who burn Remembrance Day poppies in public), and the false ‘choices’ we are offered in public services. In defending democratic rights, especially free speech, he is firmly on the side of the democrats (with the egregious exception of his opposition to freedom of movement).

Liddle’s instinct is that of a satirist. Part of the cause of the vitriol hurled at him is that nobody likes being mocked. But I think what has really infuriated reviewers is that, in the process of mocking, Liddle often transgresses the New Establishment’s most stringent rule: You Can’t Say That.

Selfish Whining Monkeys: How we Ended Up Greedy, Narcissistic and Unhappy, by Rod Liddle, is published by Fourth Estate. (Buy this book from Amazon(UK).)

This review first appeared in Spiked





Why breaking up the banks is not the solution to the UK’s economic woes

8 02 2011

 

 

 

 

 

 

*This is a seconding speech to be made at this event alongside Kitty Ussher of Demos against Phillip Blond, the so called ‘Red Tory’

The truth is that poor profitability in productive industries fed the Wall Street monster; that is why it has had so much money to play with. Sean Collins 

The argument for breaking up the big banks, to separate investment banking from retail banking, is based on a flawed analysis of the underlying causes of the financial crisis and the recession which followed. While I hold no brief for the financial sector, the public campaign to break them up is based more out of a desire for revenge than a clear understanding of what needs to be done to make our economy dynamic.

The financial boom and bust was not the product of risky behaviour by bankers, something that those who argue for the break up generally contend. Rather it was the outcome of government sponsored credit expansion policies, here and elsewhere. Low growth rates were artificially stimulated by easy credit policies. The banks were certainly complicit in this behaviour as executors of a strategy of bolstering consumption instead of investment, but they were not the cause. The banks have become scapegoats for the recession, accused by many of the same politicians who encouraged them to keep on lending when times were good.

The fault for the crisis lay with those who believed that a consumption based credit boom could continue forever. We can now see how wrong that belief is. But the real problem facing the UK economy is now laid bare. It is not insufficient consumption that is our problem, but lack of productive investment, in all types of businesses and also in the basic infrastructure of our country, in its roads, railways and power stations. Money, the most fungible of all substances, will continue to flow to where the biggest profits can be made whatever walls are built to stop it. As long as there is no profit to be made in productive investment, money will inflate the next bubble instead.

Breaking up the banks will not help to solve this problem of under investment, and the disruption to banking that would ensue may even hinder it. We need the banks to do their job of lending more effectively than they presently are. Breaking them up is likely to hinder not help that process.

Military thinkers are often criticised for always trying to fight the last war. It would be a mistake for us to now want to focus on what happened in the past rather than what needs to happen in the future. We need to forget about revenge on the bankers and focus instead on the huge task of recovering growth in our economy. The constant harping on about banks and bankers has acted as a giant displacement activity. Being envious about bonuses is far easier than working out how to solve the growth problem. Fantasies about a return to some mythical past when small businesses ruled the roost will not help us to prosper in a globalised economy. It is time to let the bankers get on with their jobs. Instead of backward looking banker bashing we should be working out how we can make this a successful country in the 21st century.





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.





The summer is over, what has changed and what needs to change?

2 09 2009

images[6]After a six week break I am returning to the fray, refreshed, reinvigorated and ready once again to try to make sense of the complex economic environment in which we live. The first thing to do is to draw up a balance sheet of what has happened in the intervening period before setting off into the future. So here goes:

1.As we explained back in May, while there are some signs that the technical recession, two or more quarters of negative economic growth, may be coming to an end, this does not mean that our problems are over. The financial crisis has to some extent been stabilised, but not resolved, through the massive and coordinated actions of central banks across the world. However the real impact of the recession is only now beginning to be felt. Unemployment is continuing to rise across the world and consumer spending is falling in most places. Real hardship is being visited on millions as a result.

2. The underlying causes of the recession have not been tackled,although there is increasing recognition in some quarters that this is the case and that we are storing up trouble for the future. The prevailing sentiment is that we should return to business as usual as fast as possible. While many see that there are problems with this approach, in the absence of any alternative plan this view will of necessity prevail.

3. There is an  intellectual void in the sphere of economics which is being filled by the irrationalities of the behavioural economists. The conclusion that many in the elite are drawing from the recession is that the view that the market is rational, which has prevailed for the past thirty years, can no longer be accepted. The problem is, as I argued in my review of a book by leading behavioural economists, that rather than this leading to a search for a more rational way of understanding and managing the economy, many are now saying that this proves that there are no rational explanations for human economic behaviour. This view and its consequences was summed up thus by Gillian Tett,

However, the unpleasant truth is that there is never going to be any complete intellectual system to explain how financial systems should work. ..That is not an easy idea to sell to politicians, voters or even regulators. After all, as Lord Turner points out, a world without a reliable compass is frightening, exhausting and time-consuming to navigate: “For the regulators of the world, once you have accepted that you don’t have an intellectual framework of ‘more market is always better’ you’re in a much more worrying space, because you don’t have an intellectual system to refer each of your decisions.”

4. In the UK the political parties are beginning to prepare for the next election in which the state of the economy is going to play a key central role. This discussion will take place in an  intellectual vacuum, or at best an intellectual climate in which the irrational is celebrated over the rational. The terms of the ‘debate’ will be over narrow issues, such as whether to call cuts in public spending ‘cuts’ (Tories)or ‘tough decisions on spending’ (Labour)

To sum up, we are entering a darker economic period with no intellectual framework nor any effective political leadership to help steer us through it. In these circumstances it is vital that more people focus on trying to comprehend the present as well as working out alternatives to what is on offer. This will remain the focus of this blog in the months before the next general election in the UK.