Phoolish economists

On a day of equity market plunges around the world, it seems timely to recommend the new book from George Akerlof and Bob Shiller, Phishing for Phools: The Economics of Manipulation and Deception. Princeton University Press have put the introduction online for free.

It explains the basic concept, introducing the gap between the standard equilibrium where people know their preferences and select to maximise utility, and the phishing equilibrium where they also maximise but do not know what their preferences are – either because of behavioural psychology or information asymmetries of one sort or another. The book gives a coherent and highly plausible explanation of why markets – although usually beneficial – can lead to undesirable outcomes: the powerful force of competition in a market will not leave profit opportunities unexploited.

As you would expect, it’s a very clearly written book with tons of examples. And it makes a simple and powerful point about the fragility of the normative, welfare economics conclusions economists tend to draw.

Prof Shiller will be in London and in Bristol (at the Economics Festival as the keynote speaker in the RES session) in November.

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Life beyond shareholder value

The peerless Izabella Kaminska (@izakaminska) of the FT linked this morning to this Andy Haldane speech, which I’d only skimmed when he made it. The speech discusses the consequences for corporate governance of the way the limited liability corporation has evolved, giving primacy to a narrow view of shareholder value. It cites en passant some terrific books both recent – Anat Admati and Martin Hellwig in The Bankers’ New Clothes, Colin Mayer’s Firm Commitment – and less recent – Berle and Means’ The Modern Corporation and Private Property and Schumpeter’s Capitalism, Socialism and Democracy.

The speech looks at the historical context of the emergence of limited liability, especially in banking. The need to which it responded was of course the increased capital requirements of the time, the Industrial Revolution getting well under way. With either partnerships of unlimited liability, banks in particular were unable to respond to crises by raising new capital. (Not that it proved straightforward in 2008-9 even with limited liability.) The speech ends with a discussion of potential corporate governance reforms, including clawing back bonuses, and modifying company law to reflect wider stakeholder interests, in addition to shareholders’ interests.

The history made me ponder, however, whether the limited liability public company largely ought to go the way of the megalosaurus? Already the growth of private equity suggests there are other financing channels chipping away at the monoculture. Perhaps when legislators ever get around to doing something, one of the corporate governance reforms needed is to reduce the role of limited liability public companies in the economy.

Meanwhile, I’m reading John Kay’s latest, Other People’s Money, an excellent read which follows up on his short-termism review, to which the Andy Haldane speech refers. A review to follow.

On not skipping over facts

I read recently Sarah Bakewell’s delightful book, How to Live: A Life of Montaigne in one question and twenty attempts at an answer. Then by chance today (possibly via @Storythings?) came across this quotation from his Complete Essays:

“I realize that if you ask people to account for “facts”, they usually  spend more time finding reasons for them than finding out whether they  are true. … They skip over the facts but carefully deduce inferences.  They normally begin thus: “How does this come about?” But does it do so?  That is what they ought to be asking.”

Quite so. The more time I spend thinking about it – and it’s quite a lot already – the more puzzling economic facts seem to be.

 

History and imagination

The last of my holiday reads, albeit finished this week, was Sapiens: A Brief History of Humankind by Yuval Noah Harari. I was a bit disappointed, as it had absolutely glowing reviews. After reading Ian Morris’s Why The West Rules For Now and his more recent Farmers, Foragers and Fossil Fuels, and Jared Diamond’s Guns, Germs and Steel, and his later Collapse, not to mention Joseph Tainter and Walter Russell Mead, I suppose it’s hard to describe anything completely new looking through the long lens on the history of civilisation. It’s quite a crowded terrain.

That isn’t to say I didn’t enjoy reading Sapiens. It’s eloquently written. I liked the emphasis on human social agency, and absence of technological or ecological determinism: “The ability to create an imagined reality out of words enabled large numbers of strangers to co-operate effectively.”

He writes of ‘imagined order’ (echose of Benedict Anderson): “We believe in a particular order not because it is objectively true but because believing in it enables us to coperate effectively and forge a better society.” He has a nice example using Peugeot, the car company. It doesn’t consist in the cars it makes, or its assets, or the people working for it – it has an existence beyind any of them, and a longevity too, kept in existence by the imagined order of the French legal system, the French state, the idea of nation states, and so on. The ‘rules of the game’ as an institutional economist might put it, are a set of Russian dolls.

It drove home for me the point that for individuals the agricultural revolution was an adverse development, although it was great for spreading Homo Sapiens genes. I liked the discussion of natural and unnatural – a distinction that pre-supposes the existence of a higher purpose, and since evolution has no purpose it is a distinction that comes from religion.

I very much enjoyed the contrasting portraits of Louis XIV of France and Barack Obama: “Dominant men have never looked so dreary as they do today. What happened to the wig, stockings, high heels?”

The book tails off a bit towards the end – the economics chapters seemed weak to me, although perhaps they wouldn’t to a non-economist. They cram the whole history of world economics with an emphasis on credit (Graeber-style) into three chapters.

Anyway, that’s it for summer paperbacks. Back to the serious reading now. Next up is John Kay’s Other People’s Money. Four pages in, and I think it’s fabulous.

Accounts and holding to account

This is the last of my posts drafted on holiday last week, and is particularly timely despite being retrospective because my review of Jane Gleeson-White’s Six Capitals, or Can Accountants Save the Planet is published in the new issue of Foreign Affairs today.

I *loved* Jacob Soll’s The Reckoning: Financial Accountability and the Making and Breaking of Nations. It gives a long historical perspective on accountancy – no, wait – and particularly its importance in literally holding leaders and politicians to account. It is also extremely well written and lively. I got much joy from learning of the 1604 book Accounting for Princes, and that there was a real Musketeer called Captain D’Artagnan, he isn’t just a creature of fiction. That Jacques Necker’s Compte Rendu sold more than 100,000 copies in one year, 1781, alone. And this description of Josiah Wedgwood’s legacy: “Sound industrial management and tableware for the middling sort.”

The book’s message is that there is a constant tension between the increasing sophistication of methods of accounting to hold to account, literally, kings or powerful companies or political leaders and the scope that sophistication creates for new ways of defrauding the people or the shareholders. So the methods of accountancy need to be embedded in a culture of honest dealing. Soll concludes that we lack that now: “Accountants have become separated from everyday culture. … All countries, rich and poor, hide the true costs of their pension benefits and health care as well as of infrastructure, off their balance sheets.” But there is no public outcry about bad public accounting, while deceitful bankers and financiers have not been held to account for the crisis. (One of my arguments in The Economics of Enough was that this situation is seriously unsustainable.)

Soll cites the proposal by Timothy Irwin of the IMF that governments should publish 50 year ahead balance sheets, but queries whether it is possible. “By separating finance into its own sphere, we have lowered our financial and political aspirations.” The numbers should be an integral part of society but are not: “If there is any historical lesson to be learned here, it is that those societies that managed to harness accounting as part of their general cultures flourished.” These have been rare – Renaissance Italian city states, the early American republic, Britain of the Glorious Revolution or for a time in the Industrial Revolution. They have been brief: Charles Davenant, one of the earliest national income accountants, tried to calculate the public finances after 1689 but by the time his Discourses on the Publick Revenues was published complained that information was being withheld.

My sole regret (as the author of GDP) about Soll’s book is that he does not cover economic statistics more generally, but rather public finances. They too matter for political accountability and are no longer doing that job (as I argue in my recent working paper). Still, it’s good to want more of a book rather than less. I highly commend The Reckoning.

Final couple of days of holiday now. I have Sarah Bakewell’s How To Live: A Life of Montaigne in one question and twenty attempts at an answer; and Sapiens: A brief history of humankind left to read.