Global gloom and community currencies

I’m late to Mervyn King’s The End of Alchemy, which as all the reviewers have noted is a very well written and interesting book. It isn’t exactly cheering. On the contrary, it cast me into gloom.

As the final chapter puts it, “Without reform of the financial system, as proposed in Chapter 7 [a set of reforms with approximately zero chance of happening…..] another crisis is certain, and the failure to tackle the disequilibrium in the world economy makes it likely it will come sooner rather than later.” The chapter goes on to say not to worry, there’s something that can be done: forgive Greek debt and break up the Euro (or go for a full political union). Globally, stop struggling with Dani Rodrik’s trilemma of democracy, national sovereignity and economic intergration – King seems prepared to give up on the third leg. Change policies in China, Japan and Germany. In short, just tackle the underlying global imbalances and all the other problems or symptoms – debt overhangs, zero interest rates etc – will resolve themselves. No problem then.

To be fair, King does speak of “the audacity of pessimism”. Trouble is, you need a lot of people to get a lot more pessimistic before such policy changes would come about. As the book also points out, the last time there was such a big re-ordering was after the 1930s and 2nd world war.

More cheering is Dave Birch’s wonderful forthcoming book Before Babylon, Beyond Bitcoin, the latest in the Perspectives series (and the first full-length one). It surveys the history and the future of money. In this blog post, Dave suggests an e-currency for Manchester (and other cities). As in his previous work, Identity is the New Money, Dave points out the close link between money and trust – indeed, Mervyn King makes this point too. So financial stability is a question of communities of trust. It’s more comforting to think about trust from the ground up rather than global imbalances and crises….



The prescience of Will Baumol

The sad news about Will Baumol’s death sent me looking at his publications, and I’ve been reading the (1950) book of his PhD thesis, Welfare Economics and the Theory of the State.

The book begins by noting that laissez faire is certainly not no-government anarchism, but the list of things the government ‘ought’ to do (defence, justice, street lights, roads….) can vary between laissez faire writers and is rather arbitrary. Can there be a set of criteria based on first principles? What about asking, “Which, if any, are the circumstances in which the people composing an economy will find that a particular extension of the authority of the government is requisite for the most efficient pursuit of their own economic interests.” The thesis seeks to answer this question by an extension of the notion of external economies in consumption and production, and concluded that this approach can yield a consistent list of government activities (and moreover one that has governments do more than is often the case, rather than less).

The book then essentially destroys some of the standard convenient assumptions of welfare economics, in amazingly prescient ways. Baumol for example argues that individual preferences are not fixed, but rather influenced by other people, that monopoly and monopolistic competition are the norm, and that there is imperfect knowledge, prefiguring behavioural economics and information economics by some decades. The book ends with an Epilogue: “The Wreck of Welfare Economics.” He writes: “The simplifying premise that these types of interdependence [ie of production costs or preferences] are negligible or non-existent is misleading. Such an assumption is not neutral; it leads inexorably to the acceptance of laissez faire.” He concludes that until economics can say more about external economies and diseconomies, in terms of empirical investigation, there is no point in applying welfare theory.



Will Baumol

The first obituaries for Will Baumol have been rightly admiring and affectionate. A number of people have linked to this excellent article about his work on A Fine Theorem. Here are obits from Vox and the Washington Post. Beatrice Cherrier has a very informative Twitter thread about him too.

Like many students of my era, I knew Baumol all too well because of his textbook Economic Theory and Operations Analysis (first published in 1961). My personal contact with him came through working with him on a lecture and essay about entrepreneurship in Scotland, one of the Allander Series of lectures in 2004 (the essay is published in New Wealth for Old Nations). In his 80s then, he had been willing to fly over to engage with a project exploring how to stimulate growth in the context of a small nation with expanded but limited policy instruments at its disposal. He was full of enthusiasm, courteous, interesting. I got in touch from time to time afterward, visiting him once in New York and exchanging emails. We chatted about economics and electronic art.

The book I know best, thanks to that Allander Lecture, is The Free Market Innovation Machine. Published in 2002, it set out the distinction between ‘big’ and ‘small’ innovations, and the regularity that big firms do small innovations and vice versa. This has become a familiar idea but I think Baumol was one of the first people to describe how well it seemd to fit what had happened and to analyse the rather complex set of social institutions and market structures to incentivise productive (rather than rent-seeking) innovation and diffusion. Like the rest of his work, it is subtle, creative, based on careful observation of how markets and businesses operate. It concerns both individual incentives and the institutional framework in which businesses and consumers exist – this well ahead of the current wave of enthusiasm in economics for institutions.

It’s hard to think of an economist who has made important contributions across such a wide range of applied micro questions – going far beyond the rightly famous ‘cost disease‘. A number of people have observed that he would have been a worthy winner of the Nobel Prize – but he seems to have paid the penalty either for being too wide-ranging, or for generally shunning complicated algebraic models. The cost disease, powerful an idea as it is, involves not a single equation.



Agents and theorists

There are three books in one in Richard Bookstaber’s The End of Theory, it seemed to me. This compĂ´te is even flagged up in the subtitle: ‘Financial Crises, the Failure of Economics, and the Sweep of Human Interaction’.

One sub-book is a tedious critique of economics, tedious because like all (the many) similar critiques it (a) says ‘economics’ but means ‘macro/financial economics’; (b) assumes economics is a monolithic subject stuck some time around 1980-85, which was indeed the height of the rational expectations, real business cycle approach. Some of the points Bookstaber makes are perfectly valid. Macroeconomists have responded to the implications of the financial crisis for their approach, but not yet enough – this is why the ESRC has funded the new ‘Rebuilding Macroeconomics‘ network. I also agree in particular with his point about economics needing to get to grips better with self-fulfilling phenomena and performativity. But, really, a lot of economists – at least in academia but I think out in the non-ivory tower world too – are now doing exactly the kind of work Bookstaber enthuses about. I’d argue that even when economists are using rational choice equilibrium modelling, or ignoring the radical uncertainty of the real world, it is often done in a knowing way – that is, understanding the assumptions fail, but using the conclusions they lead to as a way of evaluating what is happening and why. Anyway, his complaints about economics are both wearily familiar territory and decreasingly true; economics is and has been changing a lot. In finance specifically, think of Andrew Lo’s new book, Adaptive Markets.

The second element of The End of Theory is a useful mini-survey of some alternative approaches (alternative to rational choice, maximising, equilibrium) models for financial markets in particular: this includes complexity and emergent phenomena, non-ergodic processes, heuristics in decision making, and so on. None of these is novel either – for example, Paul Ormerod’s Butterfly Economics and Why Most Things Fail tackle many of the same areas, Kahneman’s Thinking Fast and Slow was a best seller and Gigerenzer’s heuristics approach is widely discussed among behavioral economists, while Taleb’s books have brought the ideas about radical uncertainty to millions. Still, having these ideas set out again in a concise and accessible way is useful.

The third book-in-a-book is a very interesting approach to an agent-based modeling approach to the financial system, looking back at the 2008 crisis. Here, the author’s expertise shines through. But this section is very condensed – I wished the whole book had been about this and had used the extra room to say more about the complexities of the financial structure and how the agent based approach can illuminate them. For example, the section on the 2007-8 liquidity crisis in US markets is fascinating but condensed. Again, agent based modeling is hardly new, and is even growing more popular in economics, but I found the detail from someone who is an experienced market participant very interesting, although the idea that agent based modelling really spells the end of theory is not really addressed explicitly.

In the end, I wondered what audience Bookstaber had in mind. The final chapter ends, “I’m a frustrated novelist.” He is a indeed a good writer but needs to work on the narrative arc. I’d have thought the three components of this book appeal to at least two different sets of readers; and it distracted at least this economist reader to have the argument keep heading off on a tangent to criticise economics: ‘And another thing,….’. I hope he goes on to write the book starting to emerge from this one diagnosing the past about an agent based future for finance. If this is the right way to model financial markets, what do we do with it?

PS I see The End of Theory is doing well on Amazon, with some 5* reviews, so my perspective may be jaundiced!


50 Economics Classics

I was very chuffed that my GDP: A Brief but Affectionate History was included in 50 Economics Classics: The greatest books distilled by Tom Butler-Bowdon. This is a mildly eclectic – and so rather interesting – list ranging from Liaquat Ahamed to Max Weber, passing through Becker, Coase, Friedman, Jacobs, Krugman, Malthus, Marx, Sen, Smith on the way.

The book has lots of additional reading suggestions, in fact a bonus 50 at the end. Each book included naturally gets only a few pages, the argument in a nutshell, but it adds up to a nice overview of 250 years of economic ideas and is actually a good starting point for someone new to economics wanting a general overview. The list is alphabetical by author but they are arranged by theme in the introduction and each chapter cross-references other on the same theme. Capturing the essence of a book in 3 pages is a difficult task. Tom Butler-Bowdon is obviously a very well-read person with this rare skill.