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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Remembrancing the national debt

My husband teased me for saying The National Debt: A Short History by Martin Slater was a rattling good read, but it is. Published in late May, it puts the ‘austerity’ debate in illuminating context.

This is the UK’s national debt we’re talking about, and the book starts in the Middle Ages and ends at the financial crisis. For government debt is about high politics, from the needs of feudal monarchs to fund armies increasingly consisting of mercenaries to the long battles – in the Civil War, literal battles – over the respective powers of monarch and Parliament, to the effective private sector default in 2008 that led to banks being bailed out with the government borrowing to purchase bank equity of uncertain future value.

The history is delivered with a light touch and nice anecdotes. For instance, income tax was so hated than both times it was scrapped after its early, temporary introduction – all the records were destroyed, by immersion in water in 1802 and by burning in 1815. It turned out, however, that there was an official called the Remembrancer whose job was to keep a copy of all government financial records. This post was so obscure, that nobody had noticed and the copies were found many years later. (Created in 1154, the post still exists. What a great job title.)

There are boxes on famous economists’ views of the National Debt – including Karl Marx, who like all the others frowned on public indebtedness. He noted that most institutions in Britain were ‘Royal’ but the debt was ‘National’: another way working people had to support, through taxes to pay the interest, the rentier classes.

I learned that the founding President of the Royal Economic Society (no, not ‘National’) was an economist I’ve never heard of: George, Viscount Goschen, whom Slater describes as “perhaps one of the most economically literate Chancellors of the Exchequer to hold office before the late 20th century.” He wrote text books, encouraged the expansion of the universities, and was also President of the Royal Statistical Society.

The book ends with a (painlessly) theoretical section setting out a very clear explanation of debt sustainability. It does involve two equations, but even the most algebra-averse reader will be able to cope. The history behind the upward-ratchet of the net debt to GDP ratio makes it all too apparent that usually governments treat their purchases of assets (such as bridges or nationalised corporations) as capital expenditure but their sales of assets as current revenue, available to be spent on political priorities. For sustainablility, the government’s primary surplus of tax revenue less current spending, relative to the size of the economy, needs to be at least as big as the debt to GDP ratio, multiplied by the gap between the interest rate and growth rate (remember Piketty‘s famous r>g inequality). A higher growth rate is always the deus ex machina hoped for by governments struggling with high debt and interest payments. Currently, the UK’s national debt would start to decline (relative to GDP) with a modest 0.9% of GDP primary surplus, but that is quite a turnaround from the present deficit.

As Slater says, however, it is not straightforward to decide what the optimal level of the debt ratio would be; there is probably no better option than waiting for growth to do the job. The book concludes with a plea for a more comprehensive accounting for the government’s finances; the experimental whole of government accounts go a long way toward including other obligations that will fall on future taxpayers. Even these do not include non-legally binding future payments – such as state pensions or the NHS – while future PFI obligations are included as notes but are not in the figures. The politics of national debt are not going to get any easier.

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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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Marketcraft

Marketcraft: How Governments Make Markets Work by Steven Vogel is a nice overview of the inextricable links between ‘state’ and ‘market’. It would be great to put to rest the concept (still reflected in verbal usage) of government and market as opposites, and the book offers the concept of ‘marketcraft’ as a device to make the point. Markets always require a framework of government action to function at all.

It isn’t as if economists believe there is such as thing as the abstract ‘free’ market – ‘free’ from government ‘interference’. As Vogel very fairly notes (while regretting the use of a competitive equilibrium as a benchmark in any way at all), not only behavioural economics but also institutional economics, market design – and he could have added industrial organisation/competition economics, labour economics, health economics and all the other applied fields – have the market as an embedded institution at their core. Competition economists like me, for instance, know that it takes sustained attention from the institutions of the state to keep a market competitive.

The book – a short one drawing on previous work – compares and contrasts the liberal makrket economy of the US with the co-ordinated market economy of Japan; although Vogel is critical of the ‘varieties of capitalism‘ approach, arguing that it overstates the differences. Liberal market economies are only differently co-ordinated, he believes. There is a tension in the argument, for Vogel argues that the US should become more like Japan while also arguing that Japan’s attempt to become more like the US has failed because it did not take account of the social norms, conventions and culture in which the economy was embedded. (To be fair, he acknowledges wholesal change in the Japanese direction would not be possible.)

Somewhat ironically, Vogel reflects on the same tension in Karl Polanyi’s The Great Transformation, noting that it both asserts that ‘the market’ becomes a separate sphere from society, commodifying a growing territory of life, and that the self-regulating free market is a myth because markets are always socially embedded.

Although the argument the book makes isn’t dramatically new, and I for one need no persuasion about having to think of markets as institutions which can be shaped and designed for better or worse, there are some nice insights. I liked the section on the language we use to perpetuate the ‘free market’ chimera: governments make ‘interventions’ rather than just ‘acting’; we speak of ‘redistribution’ rather than ‘distribution’. It was also a welcome surprise that the book doesn’t set out the usual straw man version of economics. The term ‘marketcraft’ (as an analogue to statecraft) is also very nice. Governments are always ‘intervening’ in markets even if unintentionally. For sure government failure is a real thing, yet there’s no way we can live collectively without collective actions. We call that government.

 

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Straight talk from Dani Rodrik

The legion fans of Dani Rodrik will love his new book, Straight Talk on Trade. I’m one of them, and massively respect him for warning all the rest of us economists about the political economy consequences of globalisation long before these became obvious. As he writes in the last chapter of this new book, looking at recent voting trends in many countries,  “It is dawning on economists and policymakers that they severely underestimated the political fragility of the current form of globalization…. This backlash was predictable.” He has the sombre pleasure of having predicted this for a couple of decades now.

Regular readers will find many of the thoughts in Straight Talk familiar from previous books such as The Globalization Paradox and Economics Rules, and from papers such as Rodrik’s work on ‘premature deindustrialization‘. The new book updates the issues for the present context of the political success of anti-globalizers, nationalists, statists. It argues that there is little evidence of a major retreat from economic integration, and that the rhetoric and headline measures are a useful safety valve. “What looked to contemporaries like damaging protectionism was in fact a way of letting off steam to prevent an excessive build up of political pressure. … [W]e need to place the requirements of liberal democracy ahead of those of international trade and investing.”

I’m in two minds about this line of argument. It is undeniably true that the dogma of globalization gave cover to a lot of toxic practices, from financialization and speculation to multinational tax avoidance. However, I fear the protectionist, nationalist rhetoric will create its own reality – I found the argument in The Weaponization of Trade by Jack and Rebecca Harding persausive on this. Nor am I as sure about the ‘continued resilience of the nation state’ – and see its potential fracture as a dangerous moment.

On the questions of domestic economic policy and industrial policy, though, I’m 100% with Rodrik’s argument. He points out that the policies labelled ‘structural reform’ (econ jargon for politically very difficult measures) “were only loosely correlated with turning points in economic performance.” There are no silver bullets. Rather, growth take-offs “were associated with a targeted removal ofkey obstacles to growth rather than broad liberalization and economy-wide reforms.” Measures need to be targeted, and political capital and administrative resource needs to be focused on areas where there will be an early return. “In economies that suffer from multiple distortions, small changes can make a big difference.” The best policy advice is to experiment, and try local institutional innovations.

Reflecting on the lessons of past growth take-offs and failures leads into a section on the role of economics and economists – some of this familiar from Economics Rules. Economists must pay more attention to politics if they are giving policy advice, he argues, and in particular to the scope for political innovations – ideas that can durably relax political constraints and enable measures that make people better off without threatening political upheaval. Or in other words, enable the capture of efficiency gains while more or less protecting the economic rents of existing elites. Rodrik draws an interesting parallel with technological innovations, and the role of policy entrepreneurship, learning by doing, learning by experimentation, copying, serendipity and not forgetting the role of crises. “Taking ideas seriously renders the notion of interests slippy and ephemeral. Interests are not as fixed as other economists, such as Daron Acemoglu, suggest. People may need a new idea to appreciate their interests in a different, more accurate, light. “Raising the profile of ideas would also help alleviate the tension that exists today between political economy on the one hand, and normative economics and policyy analysis on the other.”

Looking at the current political context, some new ideas are surely needed, especially when it comes to global trade and investment. Rodrik has written elsehere about the need for New Rules for the Global Economy, and argues again here that the conventional policy suggestions will fail.

Straight Talk ends on a potentially optimistic note, however: “If one lesson of history is the danger of globalization running amok, another is the malleability of capitalism.  … It was not tinkering and minor modification of existing policies that produced these achievements [the New Deal, Bretton Woods], but rather radical institutional engineering.” If big, bold ideas can be implemented, the liberal democratic order may be reinvigorated. Looking at the present crop of politicians, this is only a slightly comforting thought, but I for one will take that sliver of comfort.

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