Author Archives: Diane Coyle

Freaks of Fortune

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Jonathan Levy’s [amazon_link id=”B00AFS6LXW” target=”_blank” ]Freaks of Fortune: The Emerging World of Capitalism and Risk in America [/amazon_link]is a fascinating book. It is a history of the commodification of risk, the development of life insurance and, in time, the growth of wider markets for risk. Professor Levy, a Princeton historian, portrays the modern risk-based finance industry as the counterpart of the freedom of individuals in a capitalist society to manage their own lives. That responsibility of individuals for their own destiny meant the growth of institutions offering them the tools to do so, and the translation of highly individual risks into standard types of policy or financial instrument.

The early chapters start with the origins of risk management in marine insurance, and how those specific origins shaped early legal precedent in considering whether insurance policies should pay out. A cargo of slaves was considered insurable property whereas a working man who had taken out a policy could not successfully claim against his employer after being badly injured in an accident, because he had voluntarily taken the job, which paid a premium because of the dangers. The book’s descriptions of the historical examples are the best thing about it, revealing as they do patterns of thought so different from our own. It is particularly interesting about the link made between emancipation and the assumption of personal responsibility for risk – including by slave owners making the opposite argument, that slaves need never worry about their future as owners bore all the risks! – although I’m sure there is room for different interpretations of the historical record. (I’m a long way out of my areas of expertise here.)

There is also an interesting section on the early opposition to a secondary market in life assurance policies in the US – one existed then in the UK – and for the same kind of moral arguments that Michael Sandel raises in [amazon_link id=”184614471X” target=”_blank” ]What Money Can’t Buy[/amazon_link]. The need for policy holders to be able to gain some value from their policies (otherwise, why would they not just save money?) led to the early application of actuarial science to calculate surrender values. Indeed, early on most life policies taken out by farmers would benefit their creditors – they were used to raise working capital.The book goes on to trace the shift from a mass of small insurance companies starting up in the 19th century to the machinations of the big trusts at the turn of the century.

The underlying theme of the book is that, if we don’t put our faith in Providence, or rely on a master (whether a Feudal lord, or a slave owner, or indeed a husband), then we will of course seek other means of mitigating life’s risks. Some of these are a constant, such as storms or illness, and financial services have replaced a combination of fatalism and community support. Other risks are inherent to capitalism – “an economic system that thrives of radical uncertainty”, as the author describes it. Mitigating these means capitalism is inherently financial. However, individual responsibility for risks arising from personal choices will always have to be supplemented by collective responsibility, at a minimum by regulation of the financial services industry.

The epilogue points out that there was an era when risk seemed to have been tamed, in the 1960s, and the previously common phrase ‘freaks of fortune’, meaning the unexpected events that cause upheaval in every life, dropped out of use. The phrase lies dormant still, but that moment of stability in capitalism has passed. It is certainly obvious, post-crisis, that the state is the “risk manager of last resort”.

So it’s a fascinating story. I must say that the book was heavy-going despite the masses of terrific stories it tells – I think it’s because one has to chew quite a lot to extract the marrow of the argument, and my brief summary has no doubt not done it justice. Still, it’s worth perservering, with so much food for thought, and the stories are great. I would never have imagined finding a history of life insurance at all interesting, and it turns out to be very much so.

[amazon_image id=”B00AFS6LXW” link=”true” target=”_blank” size=”medium” ]Freaks of Fortune: The Emerging World of Capitalism and Risk in America[/amazon_image]

Culture and capitalism

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The obituaries of Albert Hirschman (like this obit in the FT) pointed me to some of his other books, in addition to [amazon_link id=”0674276604″ target=”_blank” ]Exit, Voice and Loyalty[/amazon_link]. I’ll be ordering [amazon_link id=”0691015988″ target=”_blank” ]The Passions and the Interests: Political Arguments for Capitalism Before Its Triumph[/amazon_link], of which the blurb says:

“In this volume, Albert Hirschman reconstructs the intellectual climate of the seventeenth and eighteenth centuries to illuminate the intricate ideological transformation that occurred, wherein the pursuit of material interests –so long condemned as the deadly sin of avarice –was assigned the role of containing the unruly and destructive passions of man”

[amazon_image id=”0691015988″ link=”true” target=”_blank” size=”medium” ]The Passions and the Interests: Political Arguments for Capitalism before Its Triumph[/amazon_image]

More importantly, Deirdre McCloskey cites it in her marvellous book [amazon_link id=”0226556743″ target=”_blank” ]Bourgeois Dignity: Why Economics Can’t Explain the Modern World[/amazon_link], in a section describing the emergence in the 18th century of “the emergence of the economy as an explicit object of concern,” the separation of the economic or commercial sphere from the political and social. Although capitalism is as out of fashion as it has been in a generation, it’s salutary to remember its origins as a positive social and political trend incorporating personal freedom, cultural innovation and material prosperity. As McCloskey put it in her previous book, capitalism is founded on [amazon_link id=”0226556646″ target=”_blank” ]The Bourgeois Virtues[/amazon_link]. Our current problems stem from the severing of market economics from its social roots.

McCloskey’s book has a Ferdinand Bol portrait of late 17th century Dutch wine merchants on the cover. I think I’ll need to go downstairs to ferret out Simon Schama’s [amazon_link id=”0006861369″ target=”_blank” ]The Embarrassment of Riches: An Interpretation of Dutch Culture in the Golden Age[/amazon_link], which I’ve not looked at for ages.

[amazon_image id=”0226556743″ link=”true” target=”_blank” size=”medium” ]Bourgeois Dignity: Why Economics Can’t Explain the Modern World[/amazon_image]

[amazon_image id=”0006861369″ link=”true” target=”_blank” size=”medium” ]The Embarrassment of Riches: An Interpretation of Dutch Culture in the Golden Age[/amazon_image]

Hirschman and the economists

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Naturally, the news of Albert Hirschman’s death sent me back to [amazon_link id=”0674276604″ target=”_blank” ]Exit, Voice and Loyalty[/amazon_link].

[amazon_image id=”0674276604″ link=”true” target=”_blank” size=”medium” ]Exit, Voice and Loyalty: Responses to Decline in Firms, Organizations and States[/amazon_image]

The book anticipates why Hirschman was so neglected by mainstream economists over the decades after it was published in 1970. He writes that, first, economists assume rational behaviour, so a firm might start to fail for exogenous reasons, and nothing can be done about that. The ‘agents’ are simply maximising in less favourable circumstances. Secondly, in economic models, it doesn’t matter if a firm fails because of tough competition; individual firms or ‘agents’ have no intrinsic value or status. So economists focus almost entirely on the ‘exit’ mechanism. Yet, as Hirschman writes:

“In a whole gamut of human institutions, from the state to the family, voice, however cumbrous, is all their members normally have to work with.”

Mind you, he noted that in politics too the exit mechanism is also often the focus of debate. As Alex Tabarrok noted on Marginal Revolution yesterday, often voice and exit operate together, rather than as alternatives. And Justin Fox on the HBR blog suggested one reason for neglect of Hirschman’s work is perhaps that the answer to the question, what’s the right balance of exit and voice is ‘it depends on the circumstances.’

Although more than 40 years old now, Exit, Voice and Loyalty is well worth a read. Hirschman was a brilliant economist who, along with others like Herbert Simon, never commanded the attention they deserved from the rest of the profession. He was, as the title of Jerry Adelman’s forthcoming biography puts it, truly a [amazon_link id=”0691155674″ target=”_blank” ]Worldly Philosopher[/amazon_link].

[amazon_image id=”0691155674″ link=”true” target=”_blank” size=”medium” ]Worldly Philosopher: The Odyssey of Albert O. Hirschman[/amazon_image]

The idea of progress

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A while ago I started reading [amazon_link id=”1451695764″ target=”_blank” ]Abundance: Why the Future is Better than You Think[/amazon_link], by Peter Diamandis and Steven Kotler, only to put it down part way through. It’s very readable but has a rather breathless tone which put me off. It also covers the same kind of territory of techno-optimism as the excellent [amazon_link id=”1846683572″ target=”_blank” ]An Optimist’s Tour of the Future[/amazon_link] by Mark Stevenson and [amazon_link id=”0007267126″ target=”_blank” ]The Rational Optimist: How Prosperity Evolves[/amazon_link] by Matt Ridley – even some of the examples overlap. And it has some of the environmental optimist flavour of Mark Lynas’s [amazon_link id=”000731342X” target=”_blank” ]The God Species: How the Planet Can Survive the Age of Humans[/amazon_link]. Having said this, I finished Abundance yesterday and did enjoy it.

[amazon_image id=”1451695764″ link=”true” target=”_blank” size=”medium” ]Abundance: The Future Is Better Than You Think[/amazon_image]

It is important to point out that for all the well-founded economic and environmental and political gloom in so many countries at present, there has been huge progress over our lifetimes in things that matter to us, from improved longevity and health to smartphones and low-energy lightbulbs. And that there is at present an amazing array of technological discoveries close to commercial potential – all of the innovations covered in these titles in what could be described as the techno-optimism genre.

It’s all the more important as there’s a countervailing techno-pessimism genre, including Brynjolfsson and McAfee’s [amazon_link id=”B005WTR4ZI” target=”_blank” ]Race Against the Machine[/amazon_link] arguing that innovation is making people redundant, a theme picked up by Paul Krugman in his column Rise of the Robots this week, with as a side-branch Robert Gordon asserting that innovation-driven growth is over anyway.

Why is it important to be optimistic? Because expectations about the future shape today’s decisions. Paul Krugman himself demonstrated this in a marvellous but little known 1991 QJE paper on endogenous growth theory, History Versus Expectations (pdf), showing that growth outcomes depend on expectations of a promising future outweighing the disappointments of the past.

History casts a long shadow unless the future shines a bright light. Progress only occurs when people believe in the idea of progress.

Having said that, the techno-optimists can lack important nuance. Abundance is a good example of that shortcoming. The authors allow no room for doubt, and give no space to questions such as how the investment required for the innovations they describe will be financed, how innovators will succeed when incumbents have so many relevant markets sown up, where the complementary infrastructure will come from, and how politics will navigate the sharing of costs and benefits. So I prefer (not surprisingly) my own (2001) formulation of the ‘[amazon_link id=”1587990822″ target=”_blank” ]Paradoxes of Prosperity[/amazon_link]’.

I don’t want to sound too down on Abundance just because I happen to have read some other similar books. It has loads of good nuggets of information and soundbites. For example:

“When seen through the lens of technology, few resources are truly scarce; they’s mainly inaccessible.”

“Human beings are designed to be local optimists and global pessimists.” (We are more optimistic about thing we think we can control, think we’re all more intelligent and better drivers than average etc. – although global pessimism is what helps impending disasters become self-averting. Was there a genuine Y2K problem or not?)

I was interested to learn that India has switched from being a major importer to a major exporter of cotton thanks to GM varieties.

I also really liked, for personal reasons, Bill Joy being quoted on the ‘dematerialisation’ being brought about by modern technologies. In 1996 I published The Weightless World (pdf), which used the fact that the economy of 1990 literally had no greater physical mass than the economy of 1980, thanks to minaturisation and the use of new materials and the switch towards services. Bill Joy has updated this by pointing out that one smartphone is now a phone, camera, TV screen, radio, web browser, tape recorder, range of books etc.

So, if you know someone who’s feeling – not surprisingly – pessimistic about the state of the world, you should give them one of the techno-optimism books as a seasonal gift. Cheering up the population one person at a time until we collectively believe in the possibility of progress again is an important civic duty.

[amazon_image id=”1846683572″ link=”true” target=”_blank” size=”medium” ]An Optimist’s Tour of the Future[/amazon_image]

The third globalisation

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Normally I wouldn’t review a technical book on this blog, but I think it’s worth flagging up an excellent set of lectures by John Sutton, just published as [amazon_link id=”0199274533″ target=”_blank” ]Competing in Capabilities: The Globalization Process[/amazon_link]. I’ve always been an admirer of Professor Sutton’s research, bringing the rigour of empirical industrial economics to questions of development and globalisation. He also wrote the excellent [amazon_link id=”0262692791″ target=”_blank” ]Marshall’s Tendencies: What Can Economists Know?[/amazon_link], arguing for the careful intertwining of theory and evidence in economics – if only economists would pay attention.

This new book, based on the Clarendon Lectures, sets out a model of how firms compete with each other in global markets when they have different ‘capabilities’ or sets of competitive advantages and disadvantages and compete on quality. As he argues in the introduction, globalization has gone through different phases, with theory catching up belatedly with the reality. In the 19th century, different factor endowments of land and capital drove trade based on comparative advantage, drawing on Ricardo but codified by Heckscher and Ohlin in the 1920s. Post-World War 2, the growth in trade was intra-industry and clearly not driven by different factor intensities. Paul Krugman and his successors described this in ‘monopolistic competition’ models of horizontally-differentiated goods in the 1980s.

Prof Sutton argues that the current, third, phase of globalisation has seen a growing range of products (including components) traded on international markets and, with the entry of China and similar countries, a transformation of levels of productivity and quality. He links competition on quality to the idea of the ‘capabilities’ of firms. The model is built gradually over the book, each chapter working out the implications of successive assumptions. These are: the high quality product is never driven out of the market completely; scarce capabilities are geographically clustered in specific countries; and there are some costs that are no labour costs eg materials. In later chapters he turns to the question of what determines the capabilities of firms.

Given these assumptions, a simple model generates trade that looks much like real life: some markets have a small number of very large firms; there are variations in the quality of goods traded; there is a catch-up process that is a kind of arms race between competitors. In other work, Prof Sutton has tested his models empirically.

I must add the warning that this is an equation-heavy book, so for professional economists only, but it’s exciting to see the merger of a number of separate literatures: trade theory, industrial organisation, and management. And to see them applied to developing and developed economies alike, rather than the convention that developing economies need a different kind of economics.

The book also reminded me of the excellent recent papers by Richard Baldwin on trade and supply chains – these are less technical, and there is a useful VoxEU summary with links – because he too makes the point that the character of globalisation has changed. Prof Baldwin describes it as successive ‘unbundlings’, the first in the 19th and early 20th centuries as the separation of production and consumption, the second from the second half of the 20th century onwards as the separation geographically of different stages of production. His models introduce a balance between forces of agglomeration and forces of dispersion, and offer insight into the process of offshoring and reshoring – as in this recent example of garment manufacture reviving the US.

All exciting stuff intellectually, and with some rather profound policy implications, I’d have thought, when these are worked through. After all, trade policy is still geared to the economics of trade in the 20th rather than the 21st century.

[amazon_image id=”0199274533″ link=”true” target=”_blank” size=”medium” ]Competing in Capabilities: The Globalization Process (Clarendon Lectures in Economics)[/amazon_image]