Why the World Economy Needs Another Financial Crash – a guest review by Phil Thornton of Clarity Economics

“Those drawing their incomes mainly from City (of London)
activities are relatively few. The devaluation of those claims is a necessary,
if insufficient condition for the quickening of real economic activity and
perhaps even the survival of the capitalist system.”

These words will ring true for many observers of the current
tussle between the UK Government and the big banks. But this was written in
1986 as the conclusion of a prescient article in the Financial Times
explaining why there needed to be a financial crash or a bout of inflation to
purge the system of its excesses. The author, Jan Toporowski, now Head of the Economics Department at the School of Oriental
and African Studies in London, got his wish a year later but also lost his City
job.

Now 25 years later it forms the title essay in a collection of his
subsequent writings on the danger inherent within a “financial era [where]
finance mostly finances finance”. The book, Why the World Economy Needs Another
Financial Crash (Anthem Press; 143pp; £22.95), is therefore not a focused
examination of the causes of, and solutions to the financial crisis, of which
there is a burgeoning bibliography. Instead it is a record of a journey of a
practitioner-turned-student of the era of financial deregulation that he
believes was primed to create an excess of debt that would need to be purged,
either in a controlled fashion or by a shock event that leaves the world with a
period of debt deflation.

His core focus is on the concept of financial inflation, which the
author describes as the “rise in value of the financial sector of the economy
in relation to the value of the rest.” At the heart of the book are two
chapters that form a critique of financial inflation. It is harmful, we are
told, because it changes the way the economy works, by inflating asset prices
and creating a false sense of prosperity until the cycle ends with asset
deflation that in turn can lead to debt deflation.

The book is divided into three sections. The first looks at the
history of modern finance, covering familiar themes such as the end of Bretton
Woods, the run of emerging market crises and the dominance of the Washington consensus
of economic policy but viewed against the backdrop of the battle between
economic liberals and Keynesians over how best to control global finance.

The second looks at the academic and professional culture behind
financial inflation and includes entertaining essays on the “mendacious
courtesy” of goodwill in corporate accounts, and on deleveraging as a conduit
of financial crises. They also include a pertinent pair of chapters looking at
the link between asset inflation and inequality and highlighting the awful
irony that the surge in house prices that made the rich richer encouraged poor
people to over-debt themselves to get on the ladder and fuel the growth in
subprime mortgages.

The third section brings the debate up to data with an analysis of
the causes of the current crisis. It also includes a Woody Allen-inspired
dictionary of “everything you need to know about the crisis but couldn’t find
out because experts were explaining it.”

The book is thoroughly grounded in economic history with references
to the 20th, 19th or even 17th and 18th centuries never far away and steeped
with references to the great economic thinkers. It also uses humour well,
describing financial innovations as being little use to those outside financial
markets “although this will be disputed by anyone who has used a credit card to
cut a cake”.

Ultimately the critique begs the question of what the author would
put in place to replace financial liberalism and so, as Gordon Brown once
heralded, to end the cycle of (financial) boom and bust. Toporowski looks at
the Basel proposals on capital requirements for banks but rejects them as
simply forcing businesses and households to use unregulated financial markets. He
says that a return to the credit controls of the 1950s might curb the credit
cycle but would not end the industrial business cycle, whose downward phase
would simply lead to renewed calls for another bout of credit expansion of
asset inflation. The opening 1986 essay argued that a bout of inflation was
needed to boost wages and prices and reduce the real value of debt. Given that
debts are stratospherically higher now, more extreme measures may be needed.

In case the reader is any doubt about the measures needed
Toporowski closes the book with the statement that what is needed is an
economic system that avoids both financial and industrial instability. “It is
time once more to consider socialism.”

It would have been nice – perhaps for geeks and economic
historians – to have been given details of the time of writing and the outlet
for each article to put the thinking in a context of its time. But that is a
small quibble in what is a timely and amusing contribution.

There are so many enticing new economics books coming out this spring that I couldn't fit it all into one post. I'll start the second installment with one I'm particularly looking forward to, The Triumph of the City by Edward Glaeser, published by Macmillan in March. I've had the privilege of working with Ed on projects in Glasgow (see New Wealth for Old Nations: Scotland's Economic Prospects) and Manchester (on the Manchester Independent Economic Review) so I know it will be a terrific book on urban economics and the impact of technological and structural change on cities' prospects.

From MIT Press there's a new title in the terrific Boston Review series, Government's Place in the Market by Eliot Spitzer. Also of interest are Redesigning Leadership by John Maeda; Reforming U.S. Financial Markets: Reflections Before and Beyond Dodd-Frank by Randall Kroszner and Robert Shiller; and – no doubt one of many to come on this subject – Blowout in the Gulf: The BP Oil Spill Disaster and the Future of
Energy in America by William Freudenberg and Robert Gramling. Given my techno-interests, I'm also intrigued by The Secret War Between Downloading and Uploading: Tales of the Computer as Culture Machine by Peter Lunenfeld.

Cambridge University Press has some intriguing books on offer too. I'd pick out a three-volume Economic History of Modern Britain by John Clapham, a reprint of a 1930 book. The catalogues says: “The first volume of John Harold Clapham's remarkable and original work
begins with a comprehensive description of Britain on the eve of the
Railway Age, covering topics such as the organisation of agriculture,
industry and commerce. The second volume covers the period of the Great
Exhibition and the development of the production of cheap mass-produced
steel; the railway system continued to grow and the fortunes of canals
and decline. With the third volume, Professor Clapham completes the
work, bringing the story down to 1929.” My interest is also aroused by  Individuals and Identity in Economics by John B Davis, looking at the evolving way the individual is treated in the subject, covering for example developments in neuroeconomics.

From Polity Press in March comes The New Scramble for Africa by Padraig Carmody, another welcome study about inward investment in the continent's natural resources. Yale University Press is offering What's Next: Unconventional Wisdom on the Future of the World Economy by David Hale and Lyric Hughes Hale; and The Theory That Would Not Die (about Bayes' Theorem) by Sharon Bertsch McGrayne.

These are the ones I've picked up on so far. If any publishers think I've left out prospects of interest to the general reader of economics books, do let me know and I can post a Part 3.

Publishers were out in force at the recent annual meeting of the American Economic Association, so it was a good opportunity for me to gather up the Spring 2011 catalogues. There are so many promising books coming up that I'm going to post in two parts.

I'm sure readers will forgive me for starting with Princeton University Press and my own forthcoming book The Economics of Enough: How to Run the Economy as if the Future Matters, out next month. Others that look appealing are: Blind Spots: How We Fail to Do What's Right by Max Bazerman and Ann Tenbrunsel (business ethics and decision making); Beyond Mechanical Markets: Asset Price Swings, Risk and the Role of the State by Roman Frydman and Michael Goldberg (financial markets and capital allocation); Collaborative Governance by John Donahue and Richard Zeckhauser (how private and public sectors can work together especially when money is tight); and A Co-operative Species: Human Reciprocity and its Evolution by Samuel Bowles and Herbert Gintis (a cross-disciplinary study of co-operative behaviour).

The themes evident here – markets and their misbehaviour, improving decision-making and governance, and big-picture books about society – are also demonstrated in some of the other spring lists. Harvard University Press is highlighting a number of new books on these various themes. There's The Illusion of Free Markets by Bernard Harcourt; The Crisis of Neoliberalism by Gerard Dumenil and Dominique Levy; and Maynard's Revenge: The Collapse of Modern Macroeconomics by Lance Taylor – spot the pattern in these three! I also like the look of The Shock of the Global: The 1970s in Perspective edited by Niall Ferguson and others; and Capitalizing on Crisis by Greta Krippner, an account of the US political origins of the financial crisis.

Oxford University Press has a focus on the international. Out this month is Barry Eichengreen's Exorbitant Privilege, looking at the role of the dollar.  I'm also going to be looking at The Dragon's Gift by Deborah Brautigam – high time we had a systematic study like this of China's investments in the continent.

From the University of Pennsylvania Press an edited volume on the role played by weak corporate governance in the crisis – an overlooked contributory factor – Corporate Governance Failures edited by James Hawley and others. There's also Sound Business: Newspapers, Radio and the Politics of the New Media by Michael Stamm, which looks of great interest to me wearing my BBC Trustee hat. And, not an economics book but looking incredibly timely, post-Tucson shootings, Public Discourse in America edited by Judith Rodin and Stephen Steinberg.

Turning from the university presses to general publishers, just out – and already widely reviewed (see for example today's Observer review by Paul Collier) is Dambisa Moyo's How the West Was Lost (Penguin/Allen Lane). I'd like to read that alongside Ian Morris's Why The West Rules for Now (Profile). One of the highlights of the late spring will be Tim Harford's new book Adapt, out in May in the US (Farrar Straus and Giroux) and June in the UK (Little Brown) – there is a taste of one chapter available on Tim's website. Also eagerly awaited (from Norton) is Dani Rodrik's The Globalization Paradox.

In Part 2, to follow, MIT Press, Palgrave Macmillan, Wiley, Cambridge University Press and Yale University Press.

The Browser recently carried Branko Milanovic's selection of the five books on global inequality that had most influenced his thinking on the subject. It's an eclectic mixture. I've read only the Angus Maddison book, Contours of the World Economy, which is an essential text on long-run growth trends, and long ago sections of J.A. Hobson's Imperialism. (I recently re-read and reviewed here J.A. Hobson: A Reader – he's now a regrettably little-read thinker.)

The selection set me to thinking about what else I'd recommend on this issue. On the historical evidence, David Landes' The Wealth and Poverty of Nations and The Great Divergence by Kenneth Pomeranz. On modern evidence, Milanovic's own work on inequality is essential as well, careful and
balanced empirical studies of the data shedding light on an emotive
subject. Worlds Apart: Measuring International and Global Inequality is
at the moment the definitive word on the empirical evidence.

Finally, today I also came across rather an interesting Atlantic article on the global elite by Chrystia Freedland. She describes the growing detachment of the rich from the rest and concludes:

“The lesson of history is that, in the long run, super-elites have two
ways to survive: by suppressing dissent or by sharing their wealth. It
is obvious which of these would be the better outcome for America, and
the world. Let us hope the plutocrats aren’t already too isolated to
recognize this.”

Indeed.

Of course there is a vast amount written on this subject and I'd like to hear about other people's favourites.

The session in which I took part at the 2011 American Economic Association annual meeting was about Popular Economics, chaired by Peter Dougherty of Princeton University Press and with Robert Frank, Steven Levitt and Robert Shiller as my co-panellists.

I'm sure they will each write about their own views (Bob Shiller will be posting a column for Project Syndicate) so I'll just sum up their remarks briefly. Professor Shiller kicked off by discussing the rather negative view many academic economists would take of books reaching out to the wider public. Writing accessible books doesn't help any academic's career, and some economists would anyway regard it as improper to air in public opinions not yet vetted by the process of peer review and professional scrutiny. But he disagreed, arguing that economics as a social science properly requires a debate between the profession and the public.

Robert Frank followed, arguing that he sees economists as having a duty to try to educate and influence the wider debate, perhaps especially on controversial issues such as deficit reduction. He gave the example of making the case for infrastructure spending even when the government budget has to be cut,  explaining to the wider audience (including politicians) the distinction between spending on capital and current account of the government budget.

In my remarks I made two points. The first is that there is a 'paradox of popularity' – economics books have become more and more popular with the general readership at a time when the standing of the profession is low, with economists getting at least our fair share (maybe more) of the blame for the crisis. There seem to me to be two explanations. One is that the most popular economics books are the ones that seem to 'disprove' economics, or rather, what people take economics to be about. That would include for example anything about behavioural economics or 'happiness'. I'd also include Freakonomics and similar books, because to many readers they seem to be not really about economics at all and therefore much more interesting. A second explanation for the paradox is that people still want to understand what's happening in the world in such tumultuous times, and will read the economics even if they have some degree of distrust of economists,

My second theme was that this doesn't matter anyway as long as a wider audience is reading more economics. The reason is that implementing public policies that are broadly sensible and don't fall victim to some daft headline or bandwagon is truly difficult, so anything that improves the public understanding of economics is welcome. Daniel Bell predicted in 1976, in The Coming of Post-Industrial Society, that the main faultline in modern politics would be between technical advice in circumstances of great complexity and difficulty and the populism of modern democracies. He was right, but it's much worse than he thought because we have hyper-populism with constant media and online dynamics. Just as there is now a chair in the Public Understanding of Science at Oxford University (held currently by Marcus du Sautoy) we really need one for the Public Understanding of Economics. Although of course the quid pro quo is that economists have to be humbler about the limits of our own understanding.

The final speaker was Steve Levitt (his co-author Steven Dubner was in the audience too). He made two very interesting points. One, that economists learn from the public, and as social scientists we need to understand them as much as the other way around. Secondly, that the reach of Freakonomics and its spin-offs (radio, movie, blog…) is that he can now generate data sets from the public.

I'm not sure we convinced all the audience, which consisted mainly of academic economists. While some comments were in sympathy with the panel, others seemed to consider popularisation as a side-show compared to the serious business of research. But I think more economics professors are now doing more to engage with the public, and that can only be a good thing.