What kind of state do we have?

26 06 2009

As we are are trying to work out what our approach should be towards the state and public spending, I would heartily recommend James Heartfield’s new essay on the nature of the modern UK state. In it he examines the way in which the state has  weakened its control over key economic developments by contracting out key aspects of its economic decision-making and responsibilities to consultancies and private companies,often in dubious circumstances.

Yet while the state has contracted out these key public services it has also created a more intrusive system of regulation over society through intervention in public and family life. This is one of the key aspects of the state that many of you objected to in the discussion of public spending we can do without.

James Heartfield’s conclusion is, 

All the time the established boundary between ‘state’ and ‘civil society’, between ‘public goods and private benefits’, is being redrawn, or broken down altogether. What emerges is neither an enhanced private sector, nor coherent state provision, but rather a hybrid, dependent on public finances to survive, and increasingly operating according to a mixture of political, administrative and business models that makes little sense.

 In his essay he looks in detail at some of the ways that state intervention into the banks, the railways and the NHS amongst others has acted as an indirect subsidy to private industry. More analysis along these lines would help us to understand what it is about the modern state that we object to and what we can do without.





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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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.





Say no to the politics of austerity

1 05 2009

Conservative leader David Cameron at a party conference, after delivering his 'age of austerity' speech

David Cameron has now formally identified his party as the party of austerity. He went even further in his speech to the Conservative Party Spring Conference by claiming that we are now in an ‘age of austerity’. He has identified four things that an incoming Tory government would do:

First, a return to traditional public spending control. Second, a new culture of thrift in government. Third, curing our big social problems, not just treating them. And fourth, imagination and innovation as we harness the opportunities of technology to transform the way public services are delivered.

Open season has been called on public spending. Politicians and media commentators have begun a feeding frenzy about which bits of the public services need to be cut first. There are calls for public sector pay cuts, ending public sector pensions, cancelling Trident and so on. 

But there are two things to consider here. Firstly, why are we suddenly in an ‘age of austerity’? We are in a recession, no doubt. But recessions come to an end. Why are we not in ‘age of economic opportunity’ or ‘potential economic growth’. After all, technology and science are taking us into new and ever more productive ways of making things and communicating ideas. The instinct of our political leaders to don the hair shirt at the first opportunity shows their own lack of confidence in creating a positive vision for our society.

Secondly, we need to take a step back and consider what we really want the state to do and what it would best be left out of before launching into a ‘cut this, cut that ‘ debate based on the prejudices of whichever commentator we are listening to.  Politicians are left floundering at present because they have got used to delivering policies based on focus groups rather than on any politicial vision for our society.  In a crisis such as the one we face leadership is necessary to lift people out of a narrow focus on the here and now.  The instinct of Cameron and others is to race for the lowest common denominator, hence the ‘age of austerity’. 

There is no doubt that a review of public spending priorities would be a good thing, there are some state activities which we could well do without. Take the new Independent Safeguarding Authority which at the cost of £84 million will  safety check 11 million adults who have contact with children thus exacerbating mistrust between adults and children even more than is the case now.

The question of the role of the state is one of the key issues we will be debating at the May 16 Battle for the Economy Conference.