To anybody other than an experienced and expensively-trained macroeconomist, it is pretty obvious that conventional modern macroeconomics has been torpedoed by the financial crisis and its aftermath. If we needed any reminder about the limitations of the dynamic stochastic general equilibrium model of the economy built by aggregating the behaviour of individually rational individuals, this rapidly-going-viral public resignation letter by former Goldman Sachs executive Greg Smith underlines the role of institutions, culture, morals, and all those intrinsically human characteristics.

However, one of the challenges in dethroning standard macro – because events are never enough, ideas have to follow suit – is the absence of any obvious alternative. Although it might take a while to develop the workhorse models and teaching tools, one candidate will definitely be complexity theory and network economics. I’ve just read [amazon_link id=”0415594243″ target=”_blank” ]Complex Economics: Individual and Collective Rationality[/amazon_link] by Alan Kirman, which is a moderately technical but clear explanation of how complexity/network models can be applied to economics.

Given as a series of lectures, the chapters cover specifics such as network structures, segregation models, bubbles and herding behaviour, co-ordination problems in public goods, and – my favourite – the way co-ordinated behaviour emerges in the aggregate from all sorts of individual behaviours in the fish market in Marseille. Any applied economist who has looked at actual markets (as I did for 8 years on the Competition Commission) will know that the ‘free market’ model of textbooks is a non-existent abstraction. Markets are institutions which take a variety of forms and include a mix of personal and impersonal relationships. Economists (not just [amazon_link id=”0330508601″ target=”_blank” ]Douglas Adams[/amazon_link]) like fish because they are traded in markets where there is a catch sold every day – no need to worry about inventory decisions, and lots of movement of prices and quantities.

Prof Kirman shows that prices paid for specific types of fish by different people on different days can follow all kinds of patterns, not remotely corresponding to the assumptions on preferences made in an economists’s model which aggregates from individual consumer choice to a market demand curve. Yet even so taking all the data in the aggregate reveals the standard downward-sloping relationship between quantity demanded and price. The chapter concludes that there is no simple link between individual and aggregate behaviour, although simulations that give ‘agents’ simple rules of thumb to follow in their choices do conform to the downward sloping demand curve and the real life pattern of fish market prices.

This is intriguing but it called to mind a number of studies suggesting that other creatures such as pigeons and capuchin monkeys act like rational, self-interested homo economicus in some circumstances. It would be odd to claim that real humans do not act in accordance with rational choice theory but pigeons do. Prof Kirman argues that the experiments teach the pigeons rational choice by their set up. However, I was very struck by listening to cognitive scientists at a conference in Toulouse (pdf) last autumn explain that neurons in the brain act like homo economicus in a constrained optimisation model, competing for energy as they process perceptual inputs and turn them into the things ‘we’ (our conscious mind) notice.

I don’t know how all this will add up to a new microfoundations for macroeconomics, if it ever will.  Complex Economics gives us proof-of-concept for the role this type of model can play in several areas of economics, and  think we can’t be too far away from having tractable models and programmes for applied economists and students. There’s still quite a gap between market models of this kind and a way of thinking about the economy as a whole. Meanwhile, it seems obvious to me that macroeconomists need to be eclectic and combine the complexity approach of this book, the time series macroeconometric approach of [amazon_link id=”0198283164″ target=”_blank” ]David Hendry[/amazon_link] and others, a dash of Keynesian sauce in the short run (with a laser-like focus on jobs), and plenty of history.

[amazon_image id=”0415594243″ link=”true” target=”_blank” size=”medium” ]Complex Economics: Individual and Collective Rationality (The Graz Schumpeter Lectures)[/amazon_image]

[amazon_link id=”0099541726″ target=”_blank” ]Treasure Islands[/amazon_link] – it sounds rather upbeat and enticing, but the subtitle of this bestseller by Nicholas Shaxson sets us right: Tax Havens and the Men Who Stole the World. It was published last year but I’ve just read the paperback. The central message of the book is this:

“The offshore world is not a bunch of independent states exercising their sovereign rights to set laws and tax systems as they see fit. It is a set of networks of power and influence controlled by the world’s major powers, notably Britain and the United States.” (p20)

The book sets out to establish this claim by describing the evolution of tax havens ranging from the Turks and Caicos or Caymans to Jersey, Hong Kong, Switzerland, Liechtenstein, and the US and UK themselves. It links the development of offshore finance such as the Eurobond market with the arms race towards ever-lower corporate tax rates and financial secrecy. There is an impressive amount of detail in the book. Personally, I would have preferred footnotes that did not rely so heavily on secondary sources, other books about this subject, and there is the odd tendentious assertion that strays away from the factual into the political, which weakens the impact. Having said that, I don’t want to quibble with the details.

The reason is that for many years, since I wrote a couple of chapters in Sex, Drugs and Economics (pdf file) about the illicit underground economy, the scale of this activity has appalled me. But so too has the fact that it is never discussed – with a few exceptions such as Misha Glenny’s [amazon_link id=”0099481251″ target=”_blank” ]McMafia: Seriously Organised Crime[/amazon_link]. One missing dimension from Treasure Islands is that it never quite makes the link between the large-scale global economic activity of major criminals (be they Latin American or Afghani drugs firms or the Russian or Italian mafias) and the “offshore” finance industry.

Because the criminal multinationals are operating at such a scale that, even though suitcases stuffed with large-denomination bills still abound (as Dave Birch has repeatedly pointed out, see this for example), they must as a matter of logic be accessing the formal financial system as well. From time to time the authorities force banks to freeze the assets of a particularly dreadful dictator, but most of the time the anti-money laundering rules merely stop unemployed people from opening bank accounts. They do not seem sufficiently powerful to stop funds from multinational criminals and tax evaders and avoiders finding their way into the formal financial system.

‘Offshore’ also helps explain the downward ratchet in corporate taxation (although there are other contributing factors). We are often told that corporate taxes must be kept low because capital is so mobile and will go elsewhere otherwise. The ‘elsewhere’ it will go is offshore – just look at the structure of holding companies in the Virgin Islands, Bahamas and so on set out in the accounts of virtually all major listed companies. That this kind of tax reducing structure has become so much taken for granted was illuminated when Barclays recently expressed just mild surprise that the Treasury was going to prevent its avoidance of £500m in tax.

So although I would take issue with some of the arguments in Treasure Islands, including its portrayal of the Bank of England, I applaud the way it speaks out about these matters. Immoral globalisation is driving out the potential benefits of actual economic globalisation. There is a deeper problem, too. Legitimate governments need to retain their monopoly on violence, in order to provide an ordered society ruled by law, with a high level of trust and economic transactions underpinned by enforcable contracts. They are losing this: power follows money, and it is being enforced by violence that is a challenge to democratic states. I wish more people would talk about this.

[amazon_image id=”0099541726″ link=”true” target=”_blank” size=”medium” ]Treasure Islands: Tax Havens and the Men who Stole the World[/amazon_image]

There are so many tantalising new books out, I thought I’d round up some of the weekend reviews.

Paul Collier gives a glowing review to [amazon_link id=”1846684293″ target=”_blank” ]Why Nations Fail[/amazon_link] by Daron Acemoglu and James Robinson. The blog of the book is terrific.

[amazon_image id=”1846684293″ link=”true” target=”_blank” size=”medium” ]Why Nations Fail: The Origins of Power, Prosperity and Poverty[/amazon_image]

To understand Spain still requires reading about the Civil War. Paul Preston has published what sounds like an utterly harrowing but essential book, [amazon_link id=”0002556340″ target=”_blank” ]The Spanish Holocaust[/amazon_link], reviewed in the Telegraph, FT, The Independent,  Guardian, The Herald.

[amazon_image id=”0002556340″ link=”true” target=”_blank” size=”medium” ]The Spanish Holocaust: Inquisition and Extermination in Twentieth-Century Spain[/amazon_image]

John Lanchester’s [amazon_link id=”0571234607″ target=”_blank” ]Capital[/amazon_link] has been widely reviewed – and they have been mixed, I would say. Novelist Justin Cartwright gave it a more or less positive write-up in the Financial Times. It was reviewed last week in the New Statesman, Spectator, Guardian, Independent, Telegraph.

John Kay reviews David Rothkopf’s [amazon_link id=”0374151288″ target=”_blank” ]Power, Inc[/amazon_link], about the political power exercised by large global corporations. Kay backs the argument against the recent legal interpretation of the concept of corporate personality.

In today’s Observer, Robin McKie reviews three books about the evolution of co-operation: Mark Pagel’s [amazon_link id=”1846140153″ target=”_blank” ]Wired for Culture[/amazon_link] (also covered in The Telegraph and The Guardian); [amazon_link id=”0713998172″ target=”_blank” ]Beyond Human Nature[/amazon_link] by Jesse Prinz; and Richard Sennett’s [amazon_link id=”0713998741″ target=”_blank” ]Together[/amazon_link] (also reviewed in The Telegraph and by David Runciman in The Guardian).

[amazon_image id=”1846140153″ link=”true” target=”_blank” size=”medium” ]Wired for Culture: The Natural History of Human Cooperation[/amazon_image]

I rather like the sound of [amazon_link id=”B0076O2VXM” target=”_blank” ]Turing’s Cathedral [/amazon_link]by George Dyson. It was hard to tell what reviewer Francis Spufford really made of it.

[amazon_image id=”B0076O2VXM” link=”true” target=”_blank” size=”medium” ]Turing’s Cathedral: The Origins of the Digital Universe[/amazon_image]

Not reviews as such but well worth reading in the current New York Review of Books: William Nordhaus rebuts global warming skeptics and Jennifer Homans writes about the writing of the posthumous [amazon_link id=”0434017426″ target=”_blank” ]Thinking the Twentieth Century[/amazon_link] by her late husband Tony Judt.

[amazon_image id=”0434017426″ link=”true” target=”_blank” size=”medium” ]Thinking the Twentieth Century: Intellectuals and Politics in the Twentieth Century[/amazon_image]

Out in paperback now, [amazon_link id=”0852652496″ target=”_blank” ]Mafia State [/amazon_link]by Luke Harding,[amazon_link id=”0349121516″ target=”_blank” ] andAdapt[/amazon_link] by Tim Harford.

My ticket to hear Elinor Ostrom give the Hayek Memorial Lecture at the IEA dropped through the letterbox today, prompting me to have a quick look at her marvellous book [amazon_link id=”0521405998″ target=”_blank” ]Governing the Commons: The Evolution of institutions for Collective Action[/amazon_link]. The question of institutional innovation as part of the wide range of responses needed to address inequality and the erosion of social capital has been on my mind – it was one of the issues in my recent Joseph Rowntree Foundation/University of York lecture (docx file – this is the draft, the final version will be on the JRF website soon, and the hour-long video is there). The dramatic technological innovations have undermined business as normal in politics and social engagement as much as in business, but we have not seen much institutional adaptation. It will be essential – just as social innovation in the form of mutuals, unions, co-ops, libraries, museums, the expansion of education etc constituted an essential response the the tech-driven social and economic dislocations of the 19th century.

Anyway, Ostrom’s work has looked at developing countries, but the criteria she sets out for the design of successful institutions are highly relevant to our own situation. The key question she addresses is exactly the one we face in a situation of trust being corroded by inequality and many people, from bankers to rioters, seeing what they can get away with: “How a group of principals who are in an interdependent situation can organize and govern themselves to obtain continuing joint benefits when all face temptations to free-ride, shirk, or otherwise act opportunistically.”

I don’t know if the lecture will be filmed but I will tweet with the hashtag #ostromiea from 6.45 on 29th March.

[amazon_image id=”0521405998″ link=”true” target=”_blank” size=”medium” ]Governing the Commons: The Evolution of Institutions for Collective Action (Political Economy of Institutions and Decisions)[/amazon_image]

This morning I picked up Herbert Simon’s [amazon_link id=”0684835827″ target=”_blank” ]Administrative Behavior: A Study of Decision-Making Processes in Administrative Organizations[/amazon_link]. I have the 4th edition of 1997 – the original was published in 1945. In between the 1st and 4th the computer and internet revolution happened, and so Simon added a chapter commenting on its implications. He famously pointed out that the proliferation of information increases the scarcity of attention: “The limit is not information but our capacity to attend to it.” (p226) This was indeed the subject of a fascinating workshop at the Toulouse School of Economics last September (pdf here – The Invisible Hand Meets the Invisible Gorilla).

He goes on to say that there is nothing new about drowning in information: “The information that nature presents to us is unimaginably redundant.” The challenge of today’s apparent flood of information is to find the appropriate ways of organizing and processing it. “As important as advances in hardware and software design will be advances in our understanding of human information processing – of thinking, problem solving and decision making.”

While we all admire the iPad3 and the Raspberry Pi, this is surely worth bearing in mind. If I were at the start of my career today, I’d certainly be tempted by the glamour of coding, and would definitely still love statistics and data visualization, but perhaps cognitive science and information theory would win out.

[amazon_image id=”0684835827″ link=”true” target=”_blank” size=”medium” ]Administrative Behavior: A Study of Decision-making Processes in Administrative Organizations: A Study of Decision-making Processes in Administrative Organisations[/amazon_image]