Gloomy thoughts about systemic risks

The ever-grimmer news about the spread of Ebola reminded me of the section about epidemics in the globalized world in The Butterfly Defect by Ian Goldin and Mike Mariathasan. The book is about the fragilities inherent in such an inter-linked world – economic, financial, social, environmental. And these are linked: a global pandemic will certainly have financial and economic consequences.

One of their key recommendations is that the international community needs to prepare for the realisation of big risks and be ready to act swiftly. As they acknowledge, there is nothing new about pandemics – think the Black Death or Spanish Flu after World War I. They also point out that the World Health Organisation  dealt swiftly in response to SARS, and H5N1 – indeed, they say the ability of public health authorities to act on a global basis is a model for, say, financial authorities. SARS is a “superspreader” and quickly affected large cities. Speed of response is vital, however – the book contrasts the fast reaction to SARS with the tragically slow reaction to HIV/AIDS, initially a pariah disease which prompted little response until famous people started to fall ill.

In short, early detection and system-wide early reaction are everything. It’s not clear to me that the global public health response to Ebola – a disease staring in poor, rural countries – has been fast enough.


Teaching economics

Good news from the land of the soulful science: a number of economics departments – including my own at the University of Manchester – are reviewing their undergraduate curriculum.

As someone who has been involved in the CORE project, which is being piloted in the UK by UCL this academic year, I naturally think it has a lot of appeal. It:

“Begins with ‘the capitalist revolution,’ introducing the student to what the economy is (rather than, as is more common, what economics is, generally depicted as simply the study of markets, or of constrained optimization). Our starting point focuses their attention on a series of pressing problems today – including economic prosperity, environmental challenges and inequality.  And it underlines the fact that the economy is embedded in its social and environmental context. Knowledge that comes from other disciplines – from history, political science, climate science, demography, and psychology – is part of the formation of an economist …. [The concepts included] passed two tests:  are they important in equipping students to address the major economic challenges faced by society today? And can the concepts be used in complementary ways, so that the student learns a unified, connected and multi-faceted way of understanding our economies, including their histories and the varieties of possible future economic systems that we might wish to consider?”

However, there are other alternatives beginning to emerge. Recently I’ve been looking at Peter Dorman’s two volumes, Microeconomics: A Fresh Start and Macroeconomics: A Fresh Start. In very many ways they are vastly better than many conventional textbooks such as Mankiw. They refer to the real world and recent events.

The micro volume, for example, starts by discussing economics in the context of intellectual history and also some of the building blocks: the psychology of decision-making, rationality and uncertainty, and the concept of equilibrium. It discusses values and well-being. It then looks at the range of economic  institutions, markets, firms and civil society as well. There is a more conventional section on demand and supply. Then a final chunky section on microeconomic challenges – financial markets, inequality, poverty, ecology. I would be very happy to teach from this.

I’m less well-placed to comment on the macro volume, except to say it also looks a lot better to me than the alternatives. For example, it starts with measurement of national accounts aggregates and includes institutional issues. It then proceeds by presenting different macro theories or approaches in their historical context – Keynesianism in the 60s and 70s, the turn to free marketeering, the ‘Great Moderation’ and the crisis. This is far more honest than pretending to present a settled body of knowledge.

My gripe – and it’s a big one – is that each volume is just under £50. One of the U of M students recently blogged about the price of textbooks. I don’t blame her for the complaint. No doubt there are other new textbooks on the way but I wonder if any of the publishers will opt to test the price elasticity of demand? The CORE modules are available online for free as a public good, with the effort donated by a large group of academics from around the world. Free is quite a big advantage.

A Nobel Prize for real world economics

The news that this year’s Nobel memorial prize in economics has gone to Jean Tirole is absolutely excellent, a really well-deserved award. I’m not going to compete with the swift and thorough summary already put out by Tyler Cowen. But I do want to add one comment just in case there are people out there thinking, why on earth has the prize gone to an economist who does theoretical, highly mathematical work – isn’t that yet another sign of how remote from the real world the whole discipline of economics has become? No economist who knows Tirole’s work will think so, and I’m sure there will be general delight about his selection, but maybe there are others who might make this mistake.

This is of course a common complaint about economics. It’s only partly true, and therefore partly false. There are for sure some economists who rely too much on basically very simple mathematics to gussy up economic analysis that doesn’t really need any equations. However, often economic thinking about the messy, complicated real world gets to a point at which the inter-relationships between variables are so knotty that mathematics is better able than words to keep track of them. The results are sometimes surprising.

Jean Tirole’s mathematics is of this kind. For example, in the work I know on two-sided markets (those where a platform stands between buyers and sellers), competition and market power look very different than they do in conventional markets like those for clothes or haircuts – so the conclusions competition authorities should draw from pricing on one side of the market might be very different from the usual ones. As the Scientific Background paper says:

“Tirole’s models have sharpened policy analysis. Focusing on the fundamental
features that generate a divergence between private and public interests, Tirole has
managed to characterize the optimal regulation of specific industries. Often, his rigorous
thinking has overturned previous conventional wisdom. For example, he successfully challenged the once prevalent view that monopoly power in one market cannot be profitably leveraged into another market by vertical integration. As a result, competition authorities have become more alert to the potential dangers posed by vertical integration and restraints. More generally, Tirole has shown how the justifications for public intervention frequently boil down to problems of information asymmetries and credible commitments. These general lessons — together with a catalogue of specific applications — form a robust foundation for policy analysis.”

His research has built the fundamental methods for the applied study of actual markets characterised by information asymmetries, moral hazard, lock-in, the exercise of power – features that are all too prevalent in the real world of business. It has huge practical relevance to regulators, including in the financial sector, and competition authorities. As Tyler points out, Tirole has also written on intrinsic motivation versus financial incentives.

The example of his work emphasises a broader point, which is that appropriate mathematics is essential in economics. And as Tony Yates recently pointed out, the maths needed as economics – thank goodness – gets ever closer to the real world is likely to get harder and harder. Say, if the subject takes more seriously non-linear dynamic systems, or strategic interactions between firms with different degrees of market power in a network market. Having said that, I always like F.Y.Edgeworth’s advice to regard mathematics as a kind of intellectual scaffolding, essential for the construction process, but preferably to be removed at the end.

Money as a process, not a thing

Nigel Dodd’s The Social Life of Money is fascinating. I’ve never understood money and don’t think I do yet. One of the signs of its abstraction as a concept is the way people bring their own interpretations to it, perfectly plausibly.

In my first ever job, in the Treasury in the mid-1980s, I had the task of looking at the properties of different linear combinations of deposits, all corresponding to different definitions of money – not that I over-thought it at the time. Economics textbooks over the years have blithely carried a completely fictional, institution-free account of the money multiplier, and give us probably the least plausible explanation, typically – and unhistorically – claiming money emerged from barter trade.

Information scientist Jaron Lanier’s book Who Owns The Future, which I’m currently reading, says, “Money is simply another information system.” Digital identity and currency guru Dave Birch tells us Identity is the New Money. This echoes Keith Hart in his classic The Memory Bank: “The two great memory banks are language and money. Exchange of meanings through language and of objects through money are now converging in a single network of communication, the internet.” Another anthropologist David Graeber in his tome Debt: The First 5000 Years rooted money in group cultures. Nigel Dodd is a sociologist so he gives us the sociological perspective.


Dodd’s book starts by looking at the various origin myths and links each to current (sociological) monetary theories. It then takes money by theme: capital, debt, guilt, waste, territory, culture and utopia. The chapter covering the terrain most familiar to economists is that on debt, but it takes an entirely different perspective, with Keynes and Minsky the principal economists named here. The chapter’s conclusion gives its flavour: “A monetary system that i defined by an over-arching orientation toward the interest of creditors is inimical to democracy. …. Democracy, or society, now appears to be in open conflict with the needs of finance. Debt is no longer facilitating capitalism, it is driving it.”

In a way, I found this book very heavy going because it is written in the language of sociology, and with lots of references unfamiliar to me. But it’s good for any of us to look through the lens of a different discipline. I find Dodd’s conclusion persuasive – that money is not a thing but a social process. This tallies with Dave Birch’s argument that the combination of ubiquitous mobiles and their record of a dense social graph means digital identity is fast becoming the latest manifestation of money.

Dodd also presents the paradox that money is both outside the realm of values it describes, as the means of measurement, and inside it as a particular commodity with a value – he quotes Georg Simmel as saying money is both the measure and measured. And he links this self-referential character to the capacity for financial bubbles and crises to inflate themselves. True value lies in the social life of money, in the activities of human societies.

What this means for monetary policy is another matter entirely, and Nigel Dodd’s forays into economics are far less persuasive – not that there seems to be a more compelling approach to money on offer from the macroeconomists either at the moment. Sticking a bit of ‘institutional’ friction into DSGE models to represent the banking and shadow banking sectors can only be a sticking plaster until monetary economists start to take seriously the insights to be drawn from sociologists and others.

UK bank profits are back to their pre-crisis peak

Earlier this week I attended the ONS’s regular Economic Forum, and the recent changes to the National Accounts provided one of the main subjects discussed. The slides included this one showing the old and revised profits of the financial sector in the UK:

Financial sector profits, ONS

The revision incorporates a change to the reference interest rate used in the ‘FISIM’ methodology for the finance sector (see my GDP: A Brief But Affectionate History for more on this, and also Banking Across Boundaries by Brett Christophers). Although this does not remove the absurdity that the sector’s biggest contribution to GDP growth came at the end of 2008, as the financial crisis burst upon us, it has led to sensible revisions – including the downward revision in financial sector profitability shown in the chart here, with the new red line below the old blue line.

However. it is equally striking that recent profitability has been revised up significantly, and in the most recent quarter has matched the earlier peak.

This confirms anecdotal evidence (i.e. bankers and business people I chat to) that banks have been taking advantage of low headline interest rates to increase their interest and profit margins. While they moan about the regulatory burden, this doesn’t seem to have affected their profits or bonuses at all. I hope the Competition and Markets Authority will be looking at the new ONS profitability data in its decision about whether to launch a market inquiry into the banking sector – it is due to publish its decision any time. And good luck to Colette Bowe, announced today as the new chair of the Banking Standards Review Body, set up by the banks to make them all behave better – a very impressive woman but a massive task. My firm belief is that the market structure will need to change if the ethics of people working in the sector are to improve; they aren’t all bad people, but they face terrible (from society’s perspective) incentives.

The ONS Economic Forum was full of other interesting information – including news that it will start to publish wider well-being indicators alongside the quarterly national accounts data (the third release) from December. Sarah Connor of the FT has written this up.