Meta-policy

It turns out that being involved in a start-up – the Bennett Institute for Public Policy at the University of Cambridge – is pretty busy. So although I’ve been reading, it’s a couple of weeks since I had chance to post a review. However, the passage of time means I can now write about Kaushik Basu’s The Republic of Beliefs, which is one of the most interesting and exhilarating books I’ve read for ages.

The book concerns the application of game theory to law and economics, which sounds dry but is profoundly important. Basu addresses a meta-question: why are some laws obeyed and some not? His answer voyages through the traditional law and economics literature but also social norms, history and institutions. He write: “For the law to develop roots and the rule of law to prevail requires ordinary people to believe in the law; and to believe that others believe in the law. Such beliefs and meta beliefs can take a very long time to get entrenched in society.” And, of course, it doesn’t happen in all societies.

To tackle the question, Basu looks at how to model (game theoretically) the actions of the functionaries of the state, the law enforcers. As he points out, the difference between social norms and laws is usually taken to be self-enforcement versus enforcement by the police or judiciary. So it’s necessary to think about when either kind of enforcement occurs. For how could law – “jottings on paper” – work other than by altering the payoffs of the game? There’s a logical mistake to assume that law enforcers will automatically enforce the law, as is normally done in the literature, without making an rational calculation about what’s in their best interest when everybody else is assumed to be a calculating rational maximiser.

But if the law enforcers are brought into the game rather than being assume deus ex machina, how does the law change behaviour and outcomes at all? The answer must be that it changes people’s beliefs about what other people might do. The law can try to create new focal points in the game of life: “The might of the law, even though it might be backed by handcuffs, jail and guns, is in its elemental form rooted in nothing but a configuration of beliefs carried in the heads of people in society. … It is in this sense that we are citizens of the republic of beliefs.”

This conclusion has a striking consequence: “any outcome that is made possible by creating a law could have happened without the law,” Basu argues. Outcomes can come about either through formal legislation or through informal social sanctions, although the law might help bring about the self-sustaining edifice of beliefs more readily. But laws that do not direct the economy to one of many possible equilibrium points will not be observed. Hence in societies where there is a good deal of corruption, the law is trying to enforce behaviour among law enforcers that is not in their interests, and so will fail.

Basu discusses the long shadow of history in the light of this. As he points out, there has been a good deal of attention paid (much of it outside of the field of law and economics) into how to create new focal points. Less has been paid to how to erase focal points – which is something the western democracies might well want to do after this era of madness is over, for example in terms of acceptable behaviour online or violence to individuals from ethnic minorities: “Memory, in these kinds of problems, tends to leave a residue that is hard to erase.” Law abiding behaviour founded on the belief that laws are followed is sticky, but so is its opposite.

The book speculates that in the game of life the deep ambiguity about the future – what will the set of games be? – also makes ‘focal players’ important. Some people may be able to set the meta-framework: “In war and conflict, where one has to encounter sudden and unexpected scenarios, it is important to have a well-specified leader.”

In general, we need to understand better the role of the process of the creation of laws and social norms, including how they can erode, tipping society from a ‘good’ to a ‘bad’ equilibrium. I find thinking about these regime shifts – which are clearly under way in many societies now – in these terms of self-enforcement incredibly powerful. The online world makes this doubly the case – as Basu writes: “Thanks to the march of technology, market structures are changing in ways that need smart collective interventions to make sure we do not sink the boat by each trying to enhance our own self-interest, … We may need to think of different kinds of legal and governmental interventions so enable the economy to function effectively.”

I hope nobody is put off by the appearance of game theory. This is a beautifully written book, very profound, and the small number of payoff matrices clearly explained. The Republic of Beliefs offers a distinctive and revealing perspective on public policy, and couldn’t be more timely.

 

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Private and public value

Mariana Mazzucato’s The Value of Everything: Making and Taking in the Global Economy was my Bank Holiday weekend reading. I’m entirely sympathetic to her underlying argument that a well-functioning and growing economy requires both state and market institutions to be effective; and that the opposition between the meddling state and the ‘free’ market is a bogus dichotomy. While some on the political right still see state and market as inevitably in opposition, the tide of opinion has surely decisively turned against this high-1980s trope? After all, in the UK the Conservatives too see the need for an industrial strategy, with a clear role for the government in investing and co-ordinating.

The book has four stages. The first is a summary of the history of economic thought concerning the creation of value in the economy, from mercantilism through the physiocrats to the classical economists (Smith and Marx) and then the marginalist revolution and neoclassical economics. The importance of the final step, Robbins and positivism, gets a mention but is underplayed perhaps. This section sets the scene for arguing that there is nothing inevitable about our current framing of what creates economic value.

The second stage is a summary of the history of the development of GDP as the measure of economic progress, including the treatment of finance in the national accounts. This is all well-known to me for obvious reasons, but I think also to others, given there have been a dozen or so books about economic measurement/GDP in the past few years (including mine, and most recently David Pilling with The Growth Delusion (2018)). Mazzucato makes great play of the way the definition of the financial sector has become ever more expansive to make finance look increasingly important to the economy; the authoritative work on this, including the now-notorious ‘FISIM’ definition, is Banking Across Boundaries (2013) by Brett Christophers. Mazzucato then segues into a section on the financialisation of the economy, including the pernicious effects of the ‘shareholder value’ doctrine and stock option schemes for executives.

Finally, she reprises her arguments in The Entrepreneurial State about the role of the state in innovation, the need for taxpayers to get a bigger share in the returns, and a wider riff about the growth of monopoly rents due to excessive intellectual property protection (Exhibit A is the pharmaceutical industry) and market power (the digital giants). In these contexts, she argues, more state intervention would make markets work better. In an echo of the wider debate about economic institutions, she argues that the Anglo-Saxon structures have become extractive or exploitative, rather than value-creating. I was briefly excited by her use of the term ‘public value’, with the BBC as an example; but she does not reference the political science literature on public value or that the BBC actually implemented formal public value processes. The book instead links the term to Elinor Ostrom’s work on collective decisions (wonderful as it is).

I have a few quibbles. For example, Mazzucato several times refers to GDP as a measure of legal marketed activities; the formal definition now includes illegal marketed activities. It would have reinforced her argument had she pointed out the absurdity of GDP including prostitution while excluding childcare in the home. I found aspects of her description of the production boundary confusing (and it features prominently through the book as an expository device), no doubt because my mind is shaped by the current formal definition in the SNA. This is GDP-nerd territory.

Overall, The Value of Everything is a powerful contribution to the public debate about the kind of economy and society we want. The argument that the political/financial system has become exploitative  will strike a chord with many readers. Mazzucato does not give practical policy advice here. But I’m sure this book by such an influential economist will have a big impact in contributing to the shaping of a different, and more productive, climate of opinion about government and markets.

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Power and legitimacy

Paul Tucker’s book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State is a significant contribution to the literature about the trade-off between participatory democratic influence over policy decisions and the technical complexity of much policy and regulatory activity. The focus is on central banking, not surprisingly given the author’s long experience at the Bank of England. However, the book also dips into competition policy. This is my territory, having spent 8 years on the Competition Commission. I’m not entirely convinced by the argument here.

Tucker’s conclusion is that when politicians delegate policy decisions to independent, technocratic bodies, they need to do so in accordance with some key ‘principles of delegation’. To date, they have not done so, and hence the crisis of legitimacy, at least as far as it applies to economic institutions. There are five design principles: there should be a clear statement of the body’s purposes, objectives and powers, to stop mission creep; its operating procedures should be set out; so should its operating principles – how will it go about conducting its delegated policies; there should be sufficient transparency that the institution can be monitored and held to accunt by elected politicians; and there should be some rules for how it can respond to emergencies.

These seem on the face of it perfectly reasonable. But pause on the third – central banks and independent competition authorities should have the way they implement policy set out for them. Thus, Tucker argues, a competition authority’s remit might be set in broad terms as ensuring markets are competitive, or ensuring there is no abuse of dominance; but it should not be left to the competition authorities themselves to turn this into operational rules. He notes that there have been significant changes in competition policy in the US and EU over time, shifting from the older institutionalist tradition to a focus on consumer welfare. As the book notes, this reflected developments in economic theory, adding: “The significance of these momentous changes is not whether they were grounded in good economics but that each occurred without any amendments to the governing legislation.” Thus, “This gives us a glimpse of why the public might not be clear about the pupose and objectives of antitrust regimes.”

Like a number of commentators on competition policy recently, Tucker believes – wrongly  – that the ‘Chicago School’ approach of using a consumer welfare criteria means competition authorities can only look at prices. On the contrary, although that has been the practice (because measuring prices is easier), they can take into account other aspects of economic welfare such as quality or range, or incentives to invest and innovate – this is set out in the CMA’s guidance documents, for instance. In the world of zero priced digital goods, that is exactly what they should do.

But that’s by the by. My hesitation about this principle is that the alternative – having operating rules set by elected politicians – would in reality defeat the purpose of giving economic regulators their independence. For what would stop legislators deciding that the economy is best served by preserving jobs at incumbent firms because they have the biggest economies of scale? This would be the pre-independence world of ministers deciding all mergers on public interest grounds. The time inconsistency problem common to so many regulatory contexts would return with a vengeance if legislatures can change the operating rules whenever they choose. Better to have these rules set by the technical experts, after wide public consultation. Sure, ideologies and tides in the realm of ideas would influence them, but less, it seems to me, than in the counterfactual world. Anyway, are elected politicians so respected now that they would reinject legitimacy back into economic governance? Opinion polling suggests they are among the groups the public trusts least.

Unelected Power engages an essential debate, however. There is a crisis of legitimacy in the western democracies. With QE, central banks have launched a radical change of policy with huge distributional consequences. The book has four sections: welfare, values, incentives and power are their headings. Although it touches on all the economic regulators, it is mainly about central banking, and on this is it authoritative. It will be an essential read for everybody involved in monetary policy, or researching it. It has a long bibliography; Tucker refers to legal and political science literatures as well as economics. One flaw is that it is heavy going in parts, surprsingly because he is a compelling speaker. Nevertheless, this is an important book.

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Rational ignorance, redux

I’m preparing for the start of the new semester & picked up Mancur Olson’s The Rise and Decline of Nations, his follow up to The Logic of Collective Action. It has a wonderful clarity of explanation. For instance, explaining why it can be that tax systems are usually progressive, while their loopholes are usually regressive:

“Since the probability that a typical voter will change the outcome of an election is vanishingly small, the typical citizen is usually ‘rationally ignorant’ about public affairs. … Just as lobbies provide collective goods to special interest groups, so their effectiveness is explained by the imperfect knowledge of citizens, and this in turn is mainly due to the fact that information and calculation about effective goods is also a collective good.”

People know they pay income tax and so the headline figures need to be progressive, but few pay attention to the detail, and special interest groups (such as the well off and their professional advisers) can craft the details to suit themselves.

The book has chapters on trade, development and macro policies. Less relevant to me but equally enjoyable to read. For instance, he was on to the role of institutions in development some time before it became so prominent (and indeed helped make it prominent): “In the many countries that have failed to grow as far or as fast as the leaders, there are quite enough stupidities, rigidities and instabilities to explain the lack of success.”

I always find myself heading down rabbit holes at this stage of preparation: so much interesting stuff, old and new, to read.

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The social life of electricity, continued

I devoured Then There Was Light: Stories Powered by the Rural Electrification Scheme in Ireland on my train journey back from the Bristol Festival of Economics yesterday. It’s a delightful collection of reminiscences about this scheme taking electrification to the countryside (ie most of Ireland) during the 1940s and into the 1950s. In fact, coverage only reached 100% of all the remote islands in 2000, and some hamlets were eventually depopulated as electricity never got to them.

The book is a reminder of what a poor and agrarian country Ireland was until, well EU accession really. The essays by men who worked digging post holes and driving trucks often start with the relief they felt on getting, not only a job, but one for a government body paying decent wages. Being hired for the work changed their lives. Most are written by people who spent at least part of their childhood in darkness lit only by candles and paraffin lamps, with mothers doing all the laundy by hand. One writer calls the scheme one of the most transformative events in Ireland’s 20th century history as a nation, and by the end of the book, this doesn’t seem like hyperbole.

It’s fasinating to read about the hesitations some people had: about the cost not only of getting hooked up to start with but also the vulnerability to having to make ongoing payments for power. For many new customers, this was the first regular bill payment they experienced; about the dangers – would it harm the cattle or burn down the house? And about whether it would change the character of life for the worse. Parish priests were often key advocates for electrification, and so were women, who quickly saw the potential benefits of electrical domestic appliances. The company also had a PR and sales team – the book has illustrations showing some of the demos and delightful adverts: “Electricity saves money in the farmyard!”

Above all, the book is a reminder that all technology is social. Not only do new technologies need complementary investments  – households paying for their internal wiring and switches, or street lights, for example – people have to be able to see the benefits as well as the costs (faster milking, no more washing by hand), and these often need demonstrating in practice before they are believed. Electricity in particular is also a social technology, involving collective decisions to create and sustain the incentives to make it function. The investments are long-term, they change places dramatically; and although the technology is now old, it is both essential and dangerous.

So it is that many countries still cannot provide a consistent universal electricity supply and even advanced economies experience power cuts and underinvestment. If western political systems lose their ability to create consensus and collective, long-term action there will be many bad consequences but one of them might well be disrupted electricity supplies. This is not alarmist: I spent chunks of my teenage years doing homework by candlelight too. We had the power stations and the wires, but not the social and political infrastructure in the years of unrest and strikes in the 1970s.

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