Mulling over the strangely subdued response to the Kay Review, published at the end of last week, I was browsing through a book sent to me recently by that fine social science bookseller Sean O’Donoghue of O’Donoghue Books in Hay-on-Wye. It’s [amazon_link id=”0199589089″ target=”_blank” ]After the Great Complacence: Financial Crisis and the Politics of Reform,[/amazon_link] by Ewald Engelen and colleagues at the University of Manchester’s CRESC. The essays consider how the financial sector captured the regulators before the crisis, and have a hold on regulatory and political decisions still. The story is a mix of the intellectual grip of a particular market-based view of the world, the incentives not to rock the boat created by the pre-crisis financial boom, and the sheer politics of lobbying.

Looking at these influences as barriers to post-crisis reform, the intellectual landscape has changed and continues to change, the incentives to reform finance are strong – and yet there has been scandalously little reform of either the legal and regulatory framework or the norms of behaviour in finance. That does put lobbying under the spotlight. Yesterday I found these shocking data – which look completely sound although presented in a tendentious way  – on the amount spent by financial lobbyists in the US: $1,331 per minute, every minute since 2006. And as the book notes: “If finance succeeded in blocking significant reform in either London or New York, it would nullify reform efforts elsewhere.”

The book goes on to argue that financial lobbying has been unusually effective because it has been extremely well-organized through industry bodies (in my view there is very little competition in financial markets, much tacit collusion) and has supported a persuasive storyline about the importance of the sector to the national economy.

However, UK elections are significantly less money-driven than US ones. Perhaps I’m naive, but surely at some point our politicians will appreciate the additional votes in the widespread anger people feel about the absence of contrition or behavioural change in finance, the continuing misselling scandals, the mounting evidence of fraud and money laundering? Surely?

The CRESC authors are less optimistic and conclude that even UK political parties are too dependent on corporate funding, and the City too closed an elite. It might in the end depend on “provincial radicals”, they say, citing C Wright Mills ([amazon_link id=”0195133544″ target=”_blank” ]The Power Elite[/amazon_link]); somebody with a non-elite perspective needs to persuade us all of another story. I wish them well!

[amazon_image id=”0199589089″ link=”true” target=”_blank” size=”medium” ]After the Great Complacence: Financial Crisis and the Politics of Reform[/amazon_image]

Prompted by Mario Draghi’s decisive new tone in his recent comments, welcomed by Charles Wyplosz among others, I pulled off the shelf this morning Ben Bernanke’s [amazon_link id=”0691118205″ target=”_blank” ]Essays on the Great Depression[/amazon_link]. I was wondering what lessons from the 1920s and 1930s Mr Draghi might have in mind. The book (published in 2000) presents what had become the economics profession’s consensus that the single most important reason for the international propagation of depression was the Gold Standard. A couple of the essays pose the obvious resulting question – why was there no equilibrating real economy response to such a massive and prolonged monetary tightening? – and they present what became the consensus answer – it’s because nominal wages are sticky. But the absence of labour market adjustment and the consequent pro-cyclicality of productivity remained a ‘puzzle’ in macroeconomics for many years.

In fact, this was the subject of my doctoral thesis, at the height of the early 1980s madness of real business cycle theory. I looked at possible equilibrium explanations such as the efficiency wage hypothesis, using industry-level data. All industries turn out to behave completely differently over the course of the business cycle. It was the start of my journey from macroeconomics to micro. Meanwhile, in macroeconomics the ‘new Keynesian’ consensus took sticky nominal wages as a given.

The striking thing, though, about the Bernanke volume from 2000, and quite a lot of the discussion of the macroeconomy now, is that institutional features are largely absent from the macro policy debate. Yet perhaps the single most important lesson of the current crisis for economics is the importance of the institutions of the banking and financial sector. This is the heart of the Minsky critique of conventional models in [amazon_link id=”0071592997″ target=”_blank” ]Stablizing an Unstable Economy[/amazon_link]. The role of banking was as important in the 1930s too – see for example Benjamin Roth’s [amazon_link id=”1586489011″ target=”_blank” ]The Great Depression: A Diary.[/amazon_link] The Kay Review and the continuing Libor, money laundering and other banking scandals, are reminders that in addition to the (macro) challenge of preventing further economic slump, there is a big (microeconomic) policy challenge in market reform.

Interestingly, though, both Mr Draghi’s recent comments and Professor Wyplosz’s assessment centre on the structure of the banking sector, so the emerging attempt to stabilize the Eurozone may not be such an institution-free project. Still, the ‘meso’ layer of banking and financial markets also needs careful attention if policy makers are to get the ‘macro’ right.

[amazon_image id=”0691118205″ link=”true” target=”_blank” size=”medium” ]Essays on the Great Depression[/amazon_image]

In the moments between watching and re-watching the Olympic Opening Ceremony in the past 48 hours, I’ve been reading [amazon_link id=”0956766242″ target=”_blank” ]No Straight Lines: Making Sense of Our Non-Linear World[/amazon_link] by Alan Moore.

[amazon_image id=”0956766242″ link=”true” target=”_blank” size=”medium” ]No Straight Lines: Making Sense of Our Non-linear World[/amazon_image]

I met Alan earlier in the week to talk about the book, which is about redesigning business models taking into account both the dramatic effects of digital technologies and the multiple crises – financial, environmental, social – crashing over western economies at present. It seemed quite an apt choice of reading material, having seen Danny Boyle’s brilliant vision of a Britain socially and culturally shaped by our responses to successive technologies. This moment in time really does feel like a turning point in our collective approach to the organisation of the economy and society.

Alan Moore

Alan’s perspective as someone who has worked with many businesses over the years provides interesting examples of successful change to work on the basis of more (financially, socially, environmentally) sustainable principles, such as Yeo Valley Organic. He also looks at sectors where businesses are not adjusting well, from banking and big pharma to local newspapers. I like the way the book ranges across a huge territory, for as well as all these areas of business it also discusses health care and education. In short, it takes a systems approach, or general equilibrium as we might describe it in economics. Moore presents the current array of economic and social problems as a kind of design challenge, where what is being redesigned is the organisation of society as a whole. Insanely ambitious, but I rather like that.

His final chapter distils the lessons into six principles: be participatory; focus on craftsmanship (echoes of Richard Sennett’s [amazon_link id=”0141022094″ target=”_blank” ]The Craftsman[/amazon_link], cited here); be adaptive (Tim Harford’s [amazon_link id=”0349121516″ target=”_blank” ]Adapt[/amazon_link]); learn to live with ambiguity and uncertainty; be open, and therefore resilient; have vision.

In sum: “Imagine the impossible, then create it.” Our hero Danny Boyle would agree.

Olympics opening ceremony (photo credit: Shimelle, creative commons)

The oldest questions are the most important. Adam Smith started it with his [amazon_link id=”0199535922″ target=”_blank” ]Inquiry into the Nature and Causes of the Wealth of Nations[/amazon_link]. Over time, the developed world has come to take prosperity for granted (it might be changing), and the question has focused on why some countries have remained poor. As Bill Easterly’s book labelled it, it was [amazon_link id=”0262550423″ target=”_blank” ]The Elusive Quest for Growth[/amazon_link]. There is now a new contribution by Justin Yifu Lin, until recently the World Bank’s first non-western chief economist, [amazon_link id=”0691155895″ target=”_blank” ]The Quest for Prosperity: How Developing Economies Can Take Off[/amazon_link]. It will be a must-read for anyone interested in development economics, and for anyone rethinking the role of industrial policy in developed economies too.

I’ve always thought ‘growth miracle’ was exactly the right term for the handful of experiences of catch-up in the post-WW2 era: rare and dramatic. Each example has also had its own special characteristics; generalisation into standard policy prescriptions is difficult, and the most widely applied prescription – the so-called Washington Consensus – is discredited. So it would seem either brave or foolhardy to offer an alternative. But I think this book offers a very credible general prescription which inherently recognises that every country will need to adapt this to its own circumstances. Not surprisingly, in this post-crisis economic moonscape, Lin ditches everything about the Washington Consensus but its sensible macroeconomic stability measures. Not surprisingly, for a Chinese economist, he assumes an important role for the government, albeit a role a large and growing number of conventional neoclassical economists will find sensible.

In a nutshell, the argument is that countries must play to their comparative advantage. A resource-rich African country with ample labour but little capital (human or physical) is foolish to opt for an import-substitution policy aiming at the capital-intensive top of the value chain – as so many newly independent countries tried in the 1960s and 70s. On the other hand, they absolutely should aim to substitute simpler manufactures for imports. Import substitution of this realistic kind – a link or two along the value chain – is a “necessary step”. Often the investment and expertise will come from inward FDI.

The government should identify the kinds of activity that play to comparative advantage and strategic potential, and provide the infrastructure that will be needed. This is not ‘picking winners’ but it is making choices, as different sectors will require different infrastructure priorities. Lin calls it a ‘new structural economics’:

“It sees the state as a facilitator that helps a developing country convert its backward structure to a more modern structure in an open market economy.”

Post-crisis, it sounds more like common sense than a grand new theory, but then economists are on quite a journey these days. Lin distinguishes it, though, from an older structural economics associated with ‘big push’ development theory, in endogenising the direction in which the state should be pushing.The ideal industrial structure will change as the economy develops but will always be guided by the resources and skills available at each stage. At each stage, the market is the best allocation mechanism, but the state needs to enable development by investing in infrastructure that reduces firms’ transactions costs and enables them to compete viably in international markets. This includes ‘soft’ infrastructure. For example, freight and insurance costs in many African countries are 250% of the global average, and road transportation takes two or three times longer than in comparator Asian countries.

The book also distinguishes this framework from the approach of pre-crisis mainstream structural adjustment economics, which made the mistake, he argues, of advocating the removal of economic distortions without understanding that the distortions were second-best workarounds of strategically mistaken state support for firms that are not viable given the resources and skills available.

It is a bit dismissive of the other recent hot new trend in development economics, the use of randomised control trials, as described in Banerjee and Duflo’s [amazon_link id=”1586487981″ target=”_blank” ]Poor Economics[/amazon_link]. Lin says these are of limited use as the results do not generalise. But then, his top-down framework does not generalise either; in fact he specifically says country-specific context makes a difference for policy. It would have been nice to see him engage more with the RCT approach.

Clearly, the framework can apply to any country at any stage of development along the spectrum, and the book has a useful checklist for policymakers. Its level of generality is high, but a prescription for growth that does not say ‘all you have to do is X’ is very welcome. After a century of misfired silver bullets, some endogenous policy prescriptions are very welcome. Lin sums up his approach for me with an apt Chinese proverb: “One cannot pull up the seedlings to make them grow.”

[amazon_image id=”0691155895″ link=”true” target=”_blank” size=”medium” ]The Quest for Prosperity: How Developing Economies Can Take Off[/amazon_image]

On the train in the searing (although doubtless brief) London summer, I read a reissue of E.B.White’s 1948 essay [amazon_link id=”1892145022″ target=”_blank” ]Here is New York[/amazon_link] – written in the sultry dog days of the August of that year. It’s a delightful essay. This leapt out:

“The collision and the intermingling of these millions of foreign-born people representing so many races and creeds make New York a permanent exhibit of the phenomenon of one world. The citizens of New York are tolerant not only from disposition but from necessity. The city has to be tolerant, otherwise it would explode in a radioactive cloud of hate and rancor and bigotry. If people were to depart even briefly from the peace of cosmopolitan intercourse, the town would blow up higher than a kite. In New York smoulders every race problem there is, but the noticeable thing is not the problem but the inviolate truce.”

[amazon_image id=”1892145022″ link=”true” target=”_blank” size=”medium” ]Here is New York. With a new introduction by Roger Angell[/amazon_image]

For New York in 1948, substitute London in 2012, or any other successful global city. I wrote in [amazon_link id=”0691145180″ target=”_blank” ]The Economics of Enough[/amazon_link] about this paradox of the high degree of trust manifest in these cities, at a time when trust in so many traditional institutions and political organisations is plummeting. As the Olympics starts, the combination of impatience and tolerance towards strangers of all kinds is on ample display in London. I’ve just ordered Craig Taylor’s [amazon_link id=”184708253X” target=”_blank” ]Londoners[/amazon_link] and am really looking forward to it as one of my summer holiday reads.

[amazon_image id=”184708253X” link=”true” target=”_blank” size=”medium” ]Londoners: The Days and Nights of London Now, As Told by Those Who Love It, Hate It, Live It, Left It and Long for It[/amazon_image]