Economists behaving badly: why individual behaviour is not to blame for the recession

27 05 2009

Bromley illustrationsLast week I attended a meeting with Robert Shiller, a behavioural economist and author of Animal Spirits.  As I have discussed previously, behavioural economics is becoming increasingly influential, particularly as an explanation for the recession and how to get out of it.  Essentially Shiller and others are offering psychological reasons for why people make apparently irrational decisions in the economic sphere.

Shiller’s argument last week boiled down to saying that the recession was caused by lack of confidence, an extension of FD Roosevelt’s proclamation during the 1930s depression that ‘all we have to fear is fear itself”. If you listen to the podcast you will see that in response to  questioning from  Richard Sedley and myself, Shiller is quick to concede that psychology cannot explain everything.

Two reasons why behavioural economics is on the rise

In the current climate of economic and political meltdown however, behavioural economics does not have to be a coherent theory of everything in order to be important. It is becoming increasingly influential because it plays a dual role in the current period of turbulence:

1)  it allows us to feel that it was the mistakes of the greedy bankers, driven by over confidence and corrupted by easy money that caused the recession. In that sense it takes away the necessity to think through what really caused the recession and the underlying political and economic problems that need to be resolved.

2)  if we are irrational beings as Shiller and others suggest, then the State is justified in stepping in to protect us from ourselves. Behavioural economics becomes another reason why the State needs to intervene more, not less, in all aspects of life.

This is why behavioural economics has been taken up by the Obama administration, the British Conservatives and people in New Labour. They are all looking for an explanation, any explanation, so that they can avoid tackling the really hard issues.

Barriers to innovation and change

22 05 2009

My closing speech at the Battle for the Economy conference

Taking risksWe have to frame this discussion within a cultural and a political context. Our society has become tremendously risk averse at every level. Common sense tells us it is unlikely that we can create a more dynamic and innovative economy when we are afraid to send our children to the park on their own, and how likely are these over protected children  to become confident risk takers as they grow up?

This may seem too much of a generalisation, but if you look at the specifics of what is happening in our economy you can see the links.

Take first of some of the better commodity producing  parts of our economy, the bits which actually make new things. Foremost in these are aerospace, pharmaceuticals, bioscience and energy. Each of these industries has been subjected to intense criticism for their supposed threats to us as consumers or to the environment. The aerospace industry is held responsible for global warming , as is the energy industry. The pharmaceutical industry is held in deep suspicion of selling us drugs which cause more harm than good. The biosciences have been held back by fears of Frankenstein food amongst other things. Many of these negative sentiments have been allowed to go unchallenged by our political leaders, sunk as they are in the mire of market research led policies.

How likely is it that these industries can attract the best and brightest young people to work in them or the support they need in universities or from investors when they are held in such low esteem?

Almost every time a crisis has arisen in public confidence the instinct of our political leaders has been to cut and run: Tony Blair over the MMR scare and nearly the whole political class over nuclear power and GM food. This has helped to create a lack of trust in science  and an irrational approach to what are the most exciting areas of development in medicine and other things.

The lack of leadership has encouraged this mood of anti-science and anti-progress, so much so that when swine flu broke out in a school down the road from me local opinion was divided between those who didn’t believe some scientists’ claims that  it  was a real threat, and those who took heed of this warning, but did not believe that Tamiflu was safe and not a dangerous kin to thalidomide, for example.

Secondly, also stemming from our over inflated sense of risk is the belief that economic growth in itself, whatever the source,  is problematic. There are even people who say that recessions are good for us and for the planet. These anti-growth sentiments fly in the face of reality, as all human progress is built on material prosperity. Yet they are very influential.

Thirdly, many of these anti-growth feelings are wrapped up in the idea of the Green New Deal, which seeks that progress and development be restricted to areas that can be proven to do no harm to the planet. This narrow criterion threatens to divert investment down narrow channels and hold up progress elsewhere.

Any threat to the environment or indeed any other challenge we face, is best dealt with by encouraging scientific and economic development on a broad front. Often scientists and technologists come up with solutions to problems they were not themselves originally looking for. To narrow down the areas of scientific endeavour too much risks those serendepitous discoveries.

Even on the terms of alternative energy itself, encouraging economic growth offers the best way forward. China creates 16% of its electricity through renewable sources, compared with 4% in the UK. This is  because China ‘s demand for energy to fuel its rapidly growing economy is such that it is prepared and able to experiment and innovate on a grander scale then we are here.

Finally, in the UK we have lower than OECD levels of both VC investment and R&D, but this is not because there is an absolute shortage of investment money available. Rather, risk aversion is what dominates large investors. The roots of the financial crisis lay in the fact that vast sums of money were recycled through financial instruments with a view to spreading and avoiding risk, incredible as it now seems.

There may be a case, as people like Lord Drayson are arguing, for diverting more of our State resources into encouraging innovation, but science and innovation need to be unwrapped from the risk aversion which surrounds and infuses them at the moment. Perhaps some of the money which is going into authoritarian measures such as ID cards, or the extension of CRB checks could be diverted into encouraging productive investment instead. In other words, this is a politicial and cultural problem about priorities, not an economic one, and so it needs to be tackled at that level.

It is clearer than ever before that there is a close connection between the failures of political leadership and the problems of our economic set up. You cannot tackle one without the other. The good news is that unlike, for example, a cure for cancer, the cure for our political problems lies in our own hands in the here and now.

The Battle for the Economy is on

24 04 2009

Battle for the Economy, Institute of Ideas

Battle for the Economy
16 May 2009 (9.30 am-6.00 pm)
Googdenough College, London

On Wednesday we had a nothing budget from a politically exhausted and demoralised government.  There was a populist and financially meaningless tax rise for the rich but almost no recognition in any of the measures, or in the debate around the budget, of what we could be doing to tackle the deep seated problems of the UK economy.

This would not be so bad if there was an opposition with better ideas waiting in the wings. However the Tories have promised only one thing, to take a harder line on public spending than Labour has projected to do. In fact even this is not a real difference, for if Labour did win the next election against the odds it too would cut spending. The only reason Labour is not saying that now is to avoid alienating even further an already deeply discontented electorate.

Recently there have been efforts to suggest that the recession is coming to an end. It is certainly possible that the rate of decline is slowing . That does not mean that the recession is over, nor that there is any certainty of an early upturn. What is certain however is that the most important problems are still not being addressed. In the UK that includes the whole issue of excessive public spending.

In the coming year there will be a great deal of discussion about cutting  public sector spending. The public sector will account for around 48% of the UK economy by next year and there are no doubt parts of it which we could do without. The question of the role of the state in our society could do with a thorough examination, but it should not begin with what are the easiest parts to cut, but what kind of state we need and what role it should play.

It is issues like these which need to be subjected to the maximum public debate.  From the various discussions I have taken part in recently it is clear that many people have very strong views and opinions, some of them quite sensible, about what should be done. The dead nature of our political process means that there is very little opportunity for serious public discussion which can involve us all.

On May 16th (2009) The Battle for the Economy  conference, organised by the Institute of Ideas will begin to do just that. As you will see from both the speakers and the sessions, the Conference will directly address difficult issues led by speakers who are well informed about the background to the problems we face. I would urge you to buy your ticket now.

May 16, come and debate how to fix the recession

30 03 2009

On May 16 there will be a conference in London to debate the recession and how to fix it. I would urge you to attend. We need the fullest public discussion on what can be done to make the UK in particular recover from the economic problems we have got into.