The perfect present

One of my all-time favourite books is a slim volume of essays by Anne Fadiman, [amazon_link id=”0140283706″ target=”_blank” ]Ex Libris[/amazon_link]. It’s a book about books.

[amazon_image id=”0140283706″ link=”true” target=”_blank” size=”medium” ]Ex Libris: Confessions of a Common Reader[/amazon_image]

Although this passage in the final essay, Secondhand Prose, is about a birthday and not Christmas (and is hardly to do with economics at all – non-pecuniary utility, maybe?), it speaks volumes about how to choose the perfect present:

“On the morning of my forty-second birthday, George informed me that I was about to be spirited to a mystery destination. I followed him to the subway. We got off at Grand Central Station, where he commanded me to stand at a discreet distance during his sotto voce procurement of two round-trip tickets to somewhere. After a half-hour’s ride through the Bronx and Yonkers, we disembarked at a town called Hastings on Hudson. What could possibly await us here? A three-star restaurant? A world-class art collection? A hot-air balloon, stocked with a magnum of Veuve Cliquot and a pound of caviar, from which we would achieve a hawk’s eye view of the Hudson Valley?…Then I saw it: a weather-beaten little shop, perched on such a declivitous slope that it looked in danger of sliding into the Hudson River, with a faded blue sign over the door that said BOOKSTORE. Inside were an unkempt desk, a maze of out-of-plumb shelves and 30,000 used books.

“Seven hours later, we emerged from the Riverrun Bookshop carrying nineteen pounds of books. (I weighed them when we got home.)

“Now you know why I married my husband.”

Of course, nobody will be so foolish as to buy me a Kindle this Christmas….

In St Malo

 

Mince pies and the crisis of capitalism

Times being what they are, there was something enticing about a book titled [amazon_link id=”0674055748″ target=”_blank” ]The Crisis of Capitalist Democracy[/amazon_link]. By Richard Posner, no less, co-host of the always thought-provoking and often illuminating Becker-Posner blog. I should have been alerted by the praise on the back cover – “not exactly beach reading”, “notable for its high seriousness” – to the fact that this probably was not a good choice for the start of mince pie season. So I’m not at all sure that I’ll do it justice here.

The book, published in 2010, offers an analytical overview of the causes of the Great Financial Crisis and the subsequent depression, and traces some of the likely political consequences. The first section, the analytical narrative of events from 2001 to 2009, is extremely dense, and I speak as one who revels in reading economics papers. To put 250 pages in a nutshell, Posner pins much of the blame on Alan Greenspan and Ben Bernanke for creating the macroeconomic environment for asset price bubbles, essentially for ideological reasons in his view; and then on Hank Paulson and the US Treasury for their inconsistency in not bailing out Lehman Brothers in the autumn on 2008. (The book is entirely US-focussed.) Those mistakes having been made, it’s not clear what actions he thinks the authorities ought to have taken but didn’t, as the book rules out most possibilities including that chosen by the UK authorities, of direct government stakes in troubled banks, or the earlier Swedish option of separating troubled assets into a ‘bad bank’. Posner is particularly critical of President Obama for not having a plan when he assumed office despite the several months of transition. The message, Posner concludes, was that either the incoming Administration was as incompetent as its predecessor, or that nobody had any idea what to do.

Despite the mass of detail in this section, including 12 pages on the rescue of GM and Chrysler, it feels strikingly incomplete. There is no mention of the international dimensions of the financial crisis at all. While this book focuses on the American efforts to reform finance and the links between economic policy and US politics, this omission is surely a flaw. Still, the discussion in the second and third parts of the book does have universal interest.

Part two concerns the ideas we bring to understanding and resolving the crisis – the renewed lesson about the pervasiveness of true uncertainty, the revival of ‘Keynesian’ ideas (some more closely linked to Keynes’s writing than others), the fatally flawed model of efficient financial markets and the weaknesses of macroeconomics. He particularly cites Akerlof and Shiller on [amazon_link id=”069114592X” target=”_blank” ]Animal Spirits[/amazon_link]. Who could at this point in history disagree with Posner’s conclusion that macroeconomics needs to embrace both psychology and political science?

The third part, relatively brief, is the most interesting. Posner turns to the politics of economic and regulatory reform. He is not optimistic about the capacity of the US political system to achieve – well, anything, in fact. Again, hard to disagree (as a Robin Harding column about the current state of budget negotiations from today’s FT underlines). The legacy of the banking crisis – he agrees here with [amazon_link id=”0691142165″ target=”_blank” ]Reinhardt and Rogoff [/amazon_link]- is greater public debt. Posner describes US politics as “cumbersome, clotted, competence-challenged and even rather shady” (p387), able to respond to a true emergency (hmmmm, I think back to [amazon_link id=”0241950856″ target=”_blank” ]Hurricane Katrina [/amazon_link]and wonder) but not to continuing huge challenges. Populism won’t help, but populism we got. The inability to address the public debt and structural, growing deficits, is the crisis of American capitalist democracy.

[amazon_image id=”0674055748″ link=”true” target=”_blank” size=”medium” ]Crisis of Capitalist Democracy[/amazon_image]

The economy’s most important asset: you

The Office for National Statistics has just published a really interesting new paper estimating the size of the UK’s capital stock. The figure (£17.12 trillion in 2010) depends on certain assumptions – more on those below – but one key point is the general scale. That’s two and a half times the size of the country’s physical capital stock. Even varying the assumptions generates estimates larger than the value of all the factories, machines, vehicles etc.

No wonder both the theory and evidence (see for example Barro and Salai-i-Martin in [amazon_link id=”0262025531″ target=”_blank” ]Economic Growth[/amazon_link]) find human capital to be vital for economic growth. Although the importance of ‘education, education, education’ has become a commonplace, its role in the productive capacity of the economy is given much greater weight when you appreciate just how significant in scale the human capital stock is.

[amazon_image id=”0262025531″ link=”true” target=”_blank” size=”medium” ]Economic Growth[/amazon_image]

Interestingly, the paper estimates that the UK’s stock of human capital declined in 2010 due to the downturn. This is an effect of recession that has to be factored into any view about the productive capacity of the economy when it eventually recovers. The chart shows that the dip can be attributed mainly to lower real earnings for the highly qualified. If those made redundant or remaining unemployed can be re-employed quickly in equally good jobs, there’s no lasting damage. But otherwise recession erodes the value of these human assets.

Developing and publishing annual estimates for the human capital stock may even provide a useful corrective to the snap reactions one often gets after a natural disaster, which often present a nasty paradox of the destruction boosting economic growth because of the rebuilding required. But disaster is disaster, and the loss of lives is not only a terrible human cost but also the loss of a vital asset whose importance greatly outweighs the value of the buildings and roads.

The ONS estimates are based on the estimated lifetime earnings of the workforce, the outcome of investment in human capital through education and training. This is one of three possible approaches to measurement. One alternative measures expenditure on education and training, and the other measures educational attainment. Each has advantages and drawbacks. The main drawback of the one chosen here is that it assumes people are actually paid the value of their (marginal) contribution to economic output, and there are all kinds of reasons why that might not be true. Other assumptions concern the discount rate to apply to lifetime earnings, and labour productivity growth – the sensitivity analysis shows these do make quite a difference. Other shortcomings are that the estimates don’t take account of externalities which clearly exist, for example when the presence of other skilled people makes my own skill more valuable because employers will offer better jobs, nor of social effects of investment in human capital. The benefits of a high trust, civilised society are in a league of their own, compared to the mere economic benefits.

Nevertheless, it is very important that the ONS has undertaken this exercise, and I hope it will be updated annually. In [amazon_link id=”0691145180″ target=”_blank” ]The Economics of Enough[/amazon_link] I argue for the importance of measuring the economy’s comprehensive wealth, including human capital, to take proper account of the effect of today’s decisions on the future capacity of the economy. Without an estimate of all our assets, we simply can’t know whether the economy is on a sustainable path.

[amazon_image id=”0691145180″ link=”true” target=”_blank” size=”medium” ]The Economics of Enough: How to Run the Economy as If the Future Matters[/amazon_image]

Let’s ditch macroeconomics

Tim Besley has reviewed in Foreign Affairs three of my favourite books about economic development, [amazon_link id=”0691148198″ target=”_blank” ]Portfolios of the Poor[/amazon_link], [amazon_link id=”1586487981″ target=”_blank” ]Poor Economics[/amazon_link] and [amazon_link id=”052595189X” target=”_blank” ]More Than Good Intentions[/amazon_link]. His article is terrific, and Tim is too modest to plug his own recent book with Torsten Persson [amazon_link id=”0691152683″ target=”_blank” ]Pillars of Prosperity[/amazon_link].

Development economics is in good shape. The availability of new data sets, the use of randomized control trials and the bringing of empirical life to endogenous growth models where knowledge spillovers are vital have all contributed to its health. The growth outlook has become crucial for the developed economies, in order to escape from the present debt traps and longer term demographic constraints. We would do well to ditch conventional macroeconomics, which has failed, and look instead to applying the tools of modern development economics in our own back yards.

[amazon_image id=”1586487981″ link=”true” target=”_blank” size=”medium” ]Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty[/amazon_image]

Markets, state and economics

[amazon_link id=”1907720286″ target=”_blank” ]The Courageous State: Rethinking Economics, Society and the Role of Government[/amazon_link] by Richard Murphy has three targets, as the subtitle suggests. He scores some good hits on two of them, albeit not entirely systematically, and misses the third.

The first part of the book is a statement of some familiar state versus markets arguments, and it has to be said that markets – specifically financial markets –  have made that a much easier task than would have been the case five years ago. I’m always slightly suspicious of generalisations about ‘neoliberal thinking’ of the kind made here, as it’s a marker of political as much as economic argument. The book also misses what is to me a key point about this debate, which is that market failures and government failures will occur in the same kinds of domain and for the same kinds of reason: information asymmetries and externalities are in practice pretty hard for the state to respond to as well, so government intervention has to be supplemented with other institutional safeguards. A good example is healthcare: navigating between the perverse incentives created by the profit motive and the danger of producer capture in a state system is a difficult balance, and in either case part of the trick is a strong professional ethos of service.

Having said that, Murphy sets out the reasons for market failure with passion, and makes a clear and strong case for the unashamed use of the tax system to achieve redistribution and deliver public services. The chapter on the rationale for taxation and the effectiveness of the system is the best one, as might be expected from a tax researcher. He articulates well the widespread sense of deep dissatisfaction with our economic institutions.

The third part of the book sets out a positive vision for a ‘courageous state’, with plenty of specific tax proposals. Some of these I agree with (tax simplification), some not (a financial transactions tax – too easily avoided by financial institutions but not by you, me and our pensions, so why not instead introduce the equivalent of VAT on financial services?). But proposals are certainly welcome, and I thought this was a useful list.

The second part of the book outlines a ‘new way of economic thinking’, which doesn’t do anything at all for me. I would say that, wouldn’t I, as a conventional economist? However, if you take the question of economics as being the efficient allocation of resources, I could find nothing in this section to help me answer it. There is lots here on emotional and intellectual as well as material needs, and heaven knows nobody would deny that they matter, nor even that economic decisions and policies affect them. But the gritty stuff of opportunity cost and trade-offs is essential for analysis. Murphy seems to think that any economic tools are manifestations of ‘neo-liberalism’, even say the economics of environmental externalities. The book introduces the concept of sufficiency – and assets that there is too much finance in the economy. As it happens, I agree, but would prefer to move beyond assertion because I know there are lots of people who would disagree with me and I’d like to get beyond a battle of competing assertions. Instead, I would turn to Andy Haldane’s economic analysis (pdf) of the excessive size of the finance sector. Economics as actually practised in many places in the 1990s and 2000s may have left a lot to be desired, but Richard Murphy hasn’t convinced me of the need for a new economics.

[amazon_image id=”1907720286″ link=”true” target=”_blank” size=”medium” ]The Courageous State: Rethinking Economics, Society and the Role of Government[/amazon_image]