Enlightenment and anti-Enlightenment

Expectations matter a great deal in the way the economy evolves. When, how and why did this come about? It must have been linked to the capitalist growth take-off, because why would the future be relevant if nothing much ever changed? Emily Nacol’s An Age of Risk: Politics and Economy in Early Modern Britain links it to the British Enlightenment – specifically to the philosophy of Hobbes, Locke, Hume and Smith. She argues that they presented the future as a territory of risk in order to support their arguments about the political and economic order. What’s more, the book says, there were two sides to this: risk as a source of threat to manage and risk as an opportunity for previously unexploited profits. “When the cautious citizen acts with the future in mind, he transforms his social world in the process, now and in the future,” she writes. Hobbes created the fear, Locke introduced the tools of probabilistic calculation, Hume argues for calculated and prudent risk-taking as a path to profitable opportunities which will pay off in the long term, and Smith analyses how institutional structures can manage and mitigate – or exacerbate – risk, in Nacol’s schema.

The book is quite short but does presuppose familiarity with the four philosophers – my wider reading of their work dates back to the late 1970s and PPE, although I dip in reasonably often, so it was a bit heavy going. Having said that, the key insight about the Enlightenment as the moment when thinking about risk, an orientation toward the future, became important is interesting. Especially at what sometimes feels like a moment of anti-Enlightenment when nostalgia for an imagined (and imaginary) past has overtaken us. Time to re-read Paul Krugman’s brilliant 1991 QJE paper on history versus expectations.

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Welfare economics and octopus intelligence

It’s always a mistake to go on holiday, although we had brilliant sunshine for 3 days of walking in the Lake District (for those who know the Lakes, 3 days without rain at all is quite something). While there, I popped into Westwood Books in Sedbergh, a second hand book emporium with a small but high quality economics section. I picked up three titles, including D.M. Winch’s classic little (1971) Analytical Welfare Economics. My Public Policy Economics course has the basic welfare theorems as the scaffolding off which the material is hung; it’s non-technical but not easy. After all, these are hard problems. The Winch book (I think I read it once in the 1970s) is largely non-technical too, whereas many textbook treatments quickly become very technical. I think covering the materials without scary algebra is important for students who come from a range of economics, politics and other social science courses – with varying levels of technical/mathematical background –  and many of whom will go into policy-type jobs. However, the Winch book is also pretty abstract. As I’ve not found the ideal textbook to use in my undergraduate teaching, I’ve now decided to write it myself.

IMG_4086Meanwhile, I’ve also been reading the utterly brilliant Other Minds: The Octopus and the Evolution of Intelligent Life by Peter Godfrey-Smith. I’m interested in a dilettantish way in animal intelligence because of thinking about human economic decision-making. Pigeons and rats in some circumstances make the choices that would be predicted by economic constrained optimisation models (although as Cecelia Heyes has emphasised to me, this doesn’t mean they’re behaving like humans – the similarity stems from context not deep behavioural or genetic common factors). So do humans, of course, sometimes act like rational, optimizing homo economicus. Understanding the contextual determinants of how choices get made (by any creatures) seems crucial. Anyway, it turns out the octopus and the cuttlefish are pretty smart and – to anthropomorphise shamelessly – also rather human in their occasional stroppiness. Other Minds is simply superb, not just for its insights into the world of ‘cephalod-inclined hobbyists’. It’s lucid, thought-provoking, fascinating, funny. The key message I’ve taken so far is the importance of the feedback from actions to sense perceptions and hence to ‘consciousness’ or ‘intelligence’ – which, like any feedback loop, can reach a tipping point after which change becomes eponential. Best book of the year so far. And I say this having also read Thus Bad Begins by Javier Marias in the Lake District.

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Financial crises, past, recent and future

Very late in the day, I’ve finally read Barry Eichengreen’s Hall of Mirrors: The Great Depression, The Great Recession and the Uses – and Misuses – of History. The subtitle is a concise capsule summary. The book does a neat job weaving between the 1920s/30s and the 2000s, underlining the similarities and the significant differences. There is some nice storytelling as well, particularly in the Great Depression chapters, using colourful figures and their exploits to draw in the reader, starting with the notorious Charles Ponzi but with many others too. In fact, there’s a 20 page Dramatis Personae, so this is no abstract text but a story of actual people doing actual (bad/stupid/short-sighted) things.

Given the number of books already available about both episodes, the added value of this one needs to be in the compare and contrast, and I think it succeeds in this. The common features (apart from human frailty) lie in the dynamics of bubbles, and their roots in periods of stability and optimism; in the global character of financial market reactions and the way decisions that seem either sensible or politically necessary in one country can have immense negative externalities for others; and in the interplay between politics and economics or between democracy and technocracy. Perhaps the most important difference emphasised here is the greater scale and complexity of financial markets now. Even when people are not trying to hide misdeeds, it is not easy to identify dangerous flows or accumulations of risk.

But the book also points to the difference in policy responses: in the Great Depression the answer was more government. Given the way politics has moved, it was not the answer to the Great Financial Crisis. Eichengreen – relatively gently – points to the under-regulation of big banks and other financial institutions in key dimensions, such as the only modestly higher capital ratios and lower leverage; or the failure to reform credit ratings agencies. This gently touch, he argues, reflects the success of the monetary and fiscal policy action to avert another Great Depression: “Thus the very success with which policy makers limited the damage from the worst financial crisis in eighty years means we are likely to see another such crisis in less than eighty years.

Much less, I’d say, given how little has changed.

Anyway, I enjoyed Hall of Mirrors. I think it helps to have read other books on both episodes, as in effect half a book on each of the Great Depression and the Financial Crisis is pretty compressed. A combination of Liaquat Ahamed’s Lords of Finance and John Lanchester’s Whoops! would be perfect preparation (the latter was IOU in the US).

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Prospects for the Swedish model

There’s an interesting new book, Digitalization, Immigration and the Welfare State, by Marten Blix of Sweden’s Research Institute of Industrial Economics. It brings together two deep trends, technology and immigration, in the context of the relatively rigid labour market structures of Sweden and some other European countries. Blix asks, what are the implications for the welfare state, the high tax, high spend social contract? He argues that the combined trends are increasing inequality, and the longstanding social support for redistribution and high taxation is eroding. Sweden has been at the forefront of both trends. It ranks high on measures of digitzation, and has taken in more refugees per capita than most other European countries. It has consequently had one of the biggest increases in income inequality in the OECD (the level of inequality is still relatively low – similar to Canada or Germany).

Ultimately, the book suggests a Swedish model of social democracy can potentially survive, thanks to the country’s high productivity and high initial levels of social capital. Sweden’s public finances are also in better shape than in many other countries. However, it certainly doesn’t look like an easy path. Absorbing the new immigrants will require a focus on enhancing their skills – and also those of the already-resident. One prescription is reducing the rigidities in the labour market and housing market. Another area where greater flexibility will be needed is in accommodating the increase in work – via digital platforms for instance – outside the traditional collective wage bargaining. Some Swedish unions are apparently working to establish employment standards on the digital platforms.

As the book concludes, however, the obstacles to the reinvention of the Swedish model – or any other social contract – are not problems of economic analysis but political obstacles. Economists often talk of the need for ‘structural reform’ when this is code for ‘politically bloody difficult.’ Immigration makes the politics harder, Blix argues: “Sweden is no longer the homogeneous country it used to be and the social contract holding people together is at risk of disintegrating.” All the more dangerous, then, he says to pretend everything is fine and nothing needs to change. The newcomers have to be brought into the fold or the future of the Swedish model looks to be in doubt.

Much of this debate is of course familiar to those of us more familiar with the UK and US economies, as is the kind of political lunge to the populist right or left that accompanies these tech and migration trends. It’s interesting to read about the challenges in the context of a country that has so long been an admired model for the centre left (and even some of the centre right). I accept that it’s essential to try the kind of policy response the book suggests, hard as that is, given the do-nothing alternative. But it’s quite hard to feel optimistic these days. Even Sweden!

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Free innovation

I polished off Eric von Hippel’s Free Innovation on my Washington trip. It’s an interesting, short book looking at the viability and character of innovation by individuals – alone or co-operating in communities. It is free in two senses: the work involved is not paid; and the innovations – or at least their design – is not charged for, although it may subsequently be commercialised by the inventors or by other businesses. The viability of free innovation has been greatly extended by digital technology and the internet: there is more accessible useful information, it is easier and cheaper to co-ordinate among a group. The diffusion of innovations is also easier, although rarely as extensive as when a commercial business takes them up and markets them. In fact, von Hippel argues that there are some strong complementarities between free innovation and commercial vendors, as the latter can bring the scale economies of production and marketing, while the former can enhance the use case, the complementary know-how, that increase the value of whatever it is.

The book has a little theorising, some survey evidence on the wide scope of free innovation, and plenty of nice examples. It ends with a couple of chapters on how to safeguard the legal rights of free innovation and how the pehnomenon might be encouraged. The scope is what interests me particularly. I had already been thinking about phenomena such as open source software as a voluntary public good, which competes with marketed goods – compare Apache with Microsoft’s server software (as Shane Greenstein and Frank Nagle do here). There is clearly a growing amount of substitution across the production boundary going on.

The surveys reported in this book seem to indicate that millions of people are innovating (5-6% of respondents in the UK and US, Finland and Canada) – but equally, some of the innovations are minor contributors to economic welfare and one cannot imagine them ever having a wide market or competing with marketed equivalents. The question is how to get a handle on the scope and scale of all the open source, public good, innovation.

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