Not learning lessons from the past

You would expect a book about the 2008 financial crisis by three of the key policymakers dealing with it to aim to explain and justify the actions they took throughout the crisis. Firefighting: The financial crisis and its lessons by Ben Bernanke, Tim Geithner and Hank Paulson does this. But it doesn’t come across as being particularly self-serving. Obviously they make their case in arguing that the counterfactual world would have been far worse. But they also acknowledge the role of luck, both good and bad, and do a good job of explaining the political and institutional/legal constraints on policy responses, and the complexity, speed and chaos of the situation.

The book, which is short, with an interesting series of charts at the back, is a chronological account running from the pre-crisis boom and the relaxation of regulatory constraints on the financial sector all the way to the post-crisis… relaxation of regulatory constraints on the financial sector. It ends up being a pretty uncomfortable read as they authors think the whole shebang could happen again, but with less ability for their successors to handle it. “Somehow,” they conclude, “Washington needs to muster the courage to restock the emergency arsenal with the tools that helped end the crisis iof 2008.”

“Somehow.”

This is a US focused account, and is not trying to be a comprehensive account of the crisis. It zooms out to describe the outlines of events and the policy debates and processes. Major steps – such as the Fed becoming lender of last resort for the world through extending repo lines to foreign central banks (rightly empahsized in Adam Tooze’s Crashed as a significant step) get a sentence. There are some insider nuggets. I hadn’t known that Paulson’s brother had a senior role at Lehman just before it went under, for instance. AIG shareholders and executives do not come out of it well. It is surprisingly well-written for a book jointly authored by three senior economic policy guys.

I guess the hoped-for audience is Congress. The overwhelming message I took away is that the firefighting policy response was massively hindered by a fragmented regulatory landscape and a zeitgeist of not getting in the way of the markets. It is hard to know when the situation is moving from normal if large correction to crisis, but when that point is identified the government has to act swiftly and decisively. Many of the mis-steps identified at the time and withhindsight were due to legal limitations on the power of the Fed or Treasury to act.

Leverage has diminished somewhat (not nearly enough) since the crisis. But as we’re back in a context of a “prevailing mood” of light enforcement, and ‘regulatory arbitrage’ by the finance sector to evade what regulation there is, no greater cohesion among financial regulators in the US than before, and a long expansion with lax credit conditions – oh, and less scope for monetary and fiscal relaxation – this is all pretty alarming. Will it take another financial firestorm for the “prevailing mood” to change. Read Firefighting and worry.

Firefighting: The Financial Crisis and its Lessons
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Amartya Sen

My colleague Lawrence Hamilton has written a terrific summary of the work of Amartya Sen, in a book in Polity’s Key Contemporary Thinkers series, just called Amartya Sen. It’s a fantastic introduction to the oeuvre written in a very accessible manner. I’ve read Sen’s books most relevant to my own discipline, and his work on social choice is of course pretty technical; nevertheless, it is clearly explained here.

The deep interest all economists ought to have in Sen lies in his profound – and successful –  challenge to utilitarianism, the philosophical foundation on which economic theory has been constructed. Much of what I do now is motivated by the need to rethink the practicalities of economic policy given that the social welfare standard we think we use to compare different policy outcomes is so flawed. So for example, our Bennett Institute Wealth Economy project looking at people’s access to certain types of asset is one attempt to find a set of economic statistics to measure progress that speak to the idea of Sen’s capabilities and functionings – just as GDP growth speaks to utility.

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Having said that all economists ought to be interested, relatively few are. When I once wrote an op ed along these lines, a very distinguished senior economist emailed me to say if I wasn’t a utilitarian, I wasn’t an economist. Another very distinguished economist couldn’t see the disjuncture between Paretian welfare economics and the fact that policy economists make social welfare judgements all the time in cost benefit analysis, competition assessments, evaluations of tax policy etc. We are socialised so early and thoroughly into utility-thinking that it’s hard to step outside it.

Lawrence’s book introduces Sen’s key ideas in social choice and his concept of capabilities. I found very helpful the way it highlights the importance of incompleteness of information in turning Arrow’s work into a possibility rather than an impossibility theorem.  It also very elegantly critiques Sen’s work, largely its failure to address the practical political and institutional realities, and undue optimism about people – for instance, in Sen’s emphasis on deliberative processes. What is the role of expertise? How does political power as it is distributed in reality affect the process of deliberation? Very topical challenges, to which Sen’s work does not offer answers. As the book says, “Theories of social choice have tended to assume that people’s preferences are given, but it is a fact of life in democratic politics that on a lot of issues people do not have clear preferences.

This is an issue for economics too: the construction of the deflators used to turn nominal pound or dollar GDP into ‘real’ GDP, on which so much policy hangs, relies on a theory of constant, known preferences which determine the utility of consumption, and yet modern economic growth is all about creating wants for new goods and services for which preferences have to be created. So at a time of rapid innovation it is not at all clear what the deflators and ‘real’ GDP measures are measuring.

What is nevertheless compelling about Sen’s approach is its focus on human agency, which “Drives [Sen’s] major conceptual innovation or development but also for assessment of standards of living in all contexts: his capability approach.” It isn’t the goods that matter but what people can do with them.

In short, all economists ouht to read Sen’s major works, but if they haven’t definitely ought to read this introduction. Excellent for students too, and for people in the policy world who would like an overview.

Amartya Sen (Key Contemporary Thinkers)

 

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