Economists and Minotaurs

I was prompted by an enjoyable essay by Yanis Varoufakis for Channel 4 news to order his book, The Global Minotaur, which has just arrived via Abe Books. Actually one of the nice things about the news item was seeing an economist not kitted out in standard-issue grey suit, but rather a leather jacket.

Yanis Varoufakis - no suit

Flicking through, I’m not at all sure that I’m going to agree with Prof Varoufakis, but I’m certainly going to enjoy an economics book that not only references classic Greek mythology (that Minotaur) but also takes a longer-term perspective (back to the late 70s), relates the economics to the politics, and is well-written. I will report back when I’ve read it.

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The problem of macroeconomics

I’ve been reading an article by Joseph Stiglitz whose title made it sound very promising: Rethinking Macroeconomics: What Failed And How To Repair It. His work on how information asymmetries and uncertainty shape institutions and markets make Stiglitz a strong candidate for setting out a new approach to macroeconomics. And it’s needed. Standard macro has failed, even though many macroeconomists who have invested so much in their human capital are understandably reluctant to agree. Even with modifications such as heterogeneous agents (ie people who are not all identical) and, the standard Dynamic Stochastic General Equilibrium model is not an empirically or theoretically useful representation of an economy.

I was disappointed with the Stiglitz article, however. It’s powerful as a critique, weaker on what to put in place of the standard model, although Stiglitz rightly identifies the institutional reality of money and banking, and credit markets, as essential missing elements. (Non-economists may be surprised to learn that banking does not feature as such in conventional macro models, which are indeed highly abstract).

An alternative tack which some of the most brilliant economists around think is most promising is to look at the complexity models used by physicists and biologists. Paul Ormerod’s Butterfly Economics is a great introduction to this approach, and I’m about to start Alan Kirman’s Complex Economics: Individual and Collective Rationality. Andy Haldane at the Bank of England and Robert May have written in Nature about this modelling strategy as well. I’ve just been having another look at John McMillan’s Reinventing the Bazaar: A Natural History of Markets. It’s a terrific book which looks at the institutions and detailed operations of many specific markets. He too concludes that the complexity approach is the right one at the macro scale, adding:

“The economic system has an additional layer of complexity: its components are people, who react intelligently to it and even reshape it.”

McMillan very sensibly notes that: “[Markets] have impressive achievements; they can also work badly. Whether any particular market works well or not depends on its design.”

Economics has a rapidly improving understanding of market design principles at the sub-macro scale. But this still leaves a huge modelling gap at the aggregate level. Until some future Nobel winner comes up with an alternative workhorse macro model that can be described readily in academic papers and taught to students, whether it is a complexity model or not, we will be stuck with the standard DSGE approach. Nor is it clear to me at what level of aggregation one has to switch from the tools of the market design approach to the tools of analysing complex systems. That is the problem of macroeconomics: not only how should we do macroeconomics, but also where does the boundary between micro and macro lie?

Laissez Faire, Keynes and the goldfish bowl of history

I’ve been reading a 1926 pamphlet by Keynes, The End of Laissez Faire (originally a Hogarth Press publication of a 1924 lecture). Its argument starts out sounding almost spookily similar to the present-day backlash against market forces in general and economists in particular.

“The idea of a divine harmony between private advantage and the public good is already apparent in [Archdeacon William] Paley. But it was the economists who gave the notion a good scientific basis. Suppose that by the working of natural laws individuals pursuing their own interests with enlightenment in condition of freedom always tend to promote the general interest at the same time! Our philosophical difficulties are resolved-at least for the practical man,”

thunders Keynes in the opening section. But he goes on to say, with extensive quotations from the historical literature, that in fact it was a bowdlerised version of economics being used in political arguments. Economists never really fell for their own simplifying assumptions.

The pamphlet ends by arguing that there are strong economic grounds for certain types of state intervention in the market (although not for ‘state socialism’):

“Many of the greatest economic evils of our time are the fruits of risk, uncertainty, and ignorance. It is because particular individuals, fortunate in situation or in abilities, are able to take advantage of uncertainty and ignorance, and also because for the same reason big business is often a lottery, that great inequalities of wealth come about; and these same factors are also the cause of the unemployment of labour, or the disappointment of reasonable business expectations, and of the impairment of efficiency and production. Yet the cure lies outside the operations of individuals; it may even be to the interest of individuals to aggravate the disease.”

I do hope that as we swim around the goldfish bowl of history again, we can get beyond the stale old state versus markets debate and recognize – as in this latter quotation – that the two go hand in hand in the face of collective action problems, externalities, uncertainty and the like.

 

Classical chic?

At a recent GES/Bank of England conference on how to improve the education of economists, a paradox became apparent. The academic world is slow to change and universities have done nothing since the financial crisis to reverse the previous trend in the undergraduate economics curriculum towards a narrower and increasingly technical education. Yet all the participating employers, from investment banks to the Government Economic Service, called for students to be given more context, in the form of both history of the economy and the history of economic thought. Who would have expected an investment banker to demand more reflective graduates while the universities resist providing them?

I read a lot of history already, and am old enough that it was still a required course in my PhD program, but know shockingly little about the history of thought in economics (albeit more than many other economists – it’s a low bar). Recently I read an excellent book, Economics Evolving, by Agnar Sandmo, from which I learned a lot. Yesterday I picked up Thomas Sowell’s collection of essays On Classical Economics, which has made its way to my book pile for reasons too complicated to go into here.

Only one chapter in, it has opened my eyes. I suppose I knew that Adam Smith was an anti-colonialist, but had wiped the memory: “Great fleets and armies … acquire nothing which can compensate the expense of maintaining them,” hindering the development of the colonies while not benefiting the imperial power. James Mill described the British Empire as “a vast system of outdoor relief for the upper classes.” The classical economists opposed slavery, mainly but not only for moral reasons; they also argued that: “Its key economic weakness was the absence of the incentive of self interest by the worker,” (to quote Sowell. p7).

The classical economists were no fans of the landed aristocracy. John Stuart Mill was scathing about landlords growing richer “in their sleep”, Ricardo saw them as profiting at the expense of capitalists and workers, the productive groups in society. J.B Say even expressed a view not dissimilar to the thought-experiment of Rawls’s veil of ignorance:

“Persons, who under a vicious order of things have obtained a competent share of social enjoyments, are never in want of arguments to justify … such a state of society… If the same individuals were tomorrow required to cast anew the lots assigning them a place in society, they would find many things to object to.” (quoted p 12)

Throw in Smith’s scathing verdict on politicians who regulate everybody else’s behaviour except that of their own kind, and it all starts to sound more radical than classical. Fascinating.