The end of capitalism as people knew it

After a week on holiday reading detective fiction, I’ve devoured 1931: Debt, Crisis and the Rise of Hitler by Tobias Straumann. I’d never picked out 1931 as a particularly significant year, knowing nothing about the German banking crisis that year. Yet, the book argues, what hapened “is a story of almost biblical proportions, demonstrating how quickly a situation that seems manageable at first can spin out of control.” Greek tragedy was the comparison that came to my mind: every person doing exactly what they inevitably had to, ending in disaster because of the situation.

The book, which is highly readable, starts with an economist I’d never heard of, ‘The Raven of Zurich’, Felix Somary, the Cassandra who warned of disaster staring as early as January 1930. It didn’t happen for another 18 months, with the collapse of German banks after the Credit Anstalt collapse, so Somary was mocked. But had seen the inevitable consequences of the combination of the Depression, the burden of reparations on Germany, the international imbalances that resulted from the country seeking short term foreign capital, and the efects of consequent repeated rounds of austerity on German politics.

The circumstances were of course highly specific, yet throughout the book, there are alarming parallels with the post-GFC west. Take the Smoot-Hawley tariffs, signed into law by President Hoover despite the fact that over 1000 American economists warned him against doing so. In Germany itself, the parliamentary processes of the already weak Weimar republic were increasingly debased by extremists. The latter, prominently the Nazi party, welcomed the chaos.

By mid-1931, wages and pensions had been cut, unemployment was high and rising, there was no prospect of relief from the burden of reparations or indeed further short term financing to help Germany meet those payment – and then the main banks started to topple and experienced massive bank runs. “It felt like the end of capitalism as people knew it.” Arnold Toynbee wrote that “men and women all over the world were seriously contemplating and frankly discussing that the western system of society might break down and cease to work.” In important ways they were right.

It’s a relatively short book that reads like a thriller, and – as Straumann concludes – illustrates the fundamental point that “Only when domestic electorates are prepared to accept a loss of sovereignity for the benefit of cross-border co-operation can international institutions and agreements have a chance of working effectively.” When a debt crisis makes sustained growth difficult and  leads to repeated austerity measures, electorates start to wonder what the point is.

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Better economic forecasting

The heading of this post is not an invitation for the usual jokes about economic forecasts. It’s clear that most people think forecasting is what economists do, by and large, and that they do it badly. Indeed, some forecasts are a tissue of nonsense – pretty much any UK economcy & trade forecast from Patrick Minford these days for example, although 20 or 30 years ago he was a serious forecaster. I spent a few years myself in the mid/late 1980s doing macro forecasts for the UK and a few other countries, and later, as Economics Editor of the Independent, awarded an annual Golden Guru trophy for the UK forecast of key macro variables closest to the published figures at the time of the award – a necessary qualification because many macroeconomic statistics, especially GDP, are significantly revised over a period of years.

The revisions are with us still, but the techniques of forecasting have greatly improved since then, although of course there is a wide quality range among economic forecasters. For a non-technical guide to economic forecasting, there could be nothing better than Forecasting: An Essential Introduction by Jennifer Castle, Michael Clements and David Hendry. It is a crystal clear and intuitive explanation of what macroeconomic forecasts can and can’t do. It explains the inherent difficulties in trying to forecast the future of a complex non- linear, non-stationary system in which behaviour can be affected by forecasts themselves, all from a limited amount of past data. Better still, it explains the empirical techniques this ace team have devised to tackle some of the challenges.

My only complaint about the book is that the charts are a bit too small for my middle-aged eyesight. Although non-technical, there are lots of charts and it probably won’t make the bestseller list. However, it should be read by any student about to do a time series economietrics course, and to anybody about to start a job as a forecaster. Economics students are proficient in all the relevant software, have ploughed through the statistical theory in their econometrics courses, but anybody starting out as a forecaster naturally lacks the wisdom that comes with the experience of handling the data and seeing your lovingly estimated model produce some dreadful out-of-sample forecasts.

This book represents a treasure trove of crystallised wisdom. It offers up practical insights in clear prose. For example: “This principle of differencing is a method to remove the deterministic components of a forecasting model, by which we mean intercepts and trends. Deterministic terms capture the underlying equilbrium and growth rate of a variable of interest, so are fundamental to modeling, but can be catastrophic for forecasting when either component changes. The differencng principle can be applied to any model with an inherent equilibrium to which it corrects. … But…. if the object needing to be forecast is the level, a good performance forecasting the differences is not necessarily sufficient, as cumulating those differences may lead to an increasing divergence from the level.”

The book ends with some reflections on the limits to forecasting. Some things are inherently unpredictable – including events like the financial crisis which hinged not only on prior macroeconomic trends able to be captured in a macroeconometric model but also on unexpected policy decisions like letting Lehman Brothers go bust. But  the book notes that the forecasting process is not just about numbers but also about the narrative, at least in any macro policy context. Hendry coined the term ‘forediction’ to capture this.

No doubt the public at large will continue to mock economists and their forecasts, but they will always be needed, and in that case should be as good as economists can make them.

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Not all automation is equal

Democratic Capitalism at the Crossroads: Technological change and the future of politics by Carles Boix is a good complement to the widely reviewed The Technology Trap by Carl Frey. It takes a political science perspective on the same deep trends in technology, and even uses the same geographic shorthand for the succession of technological/economic paradigms: Manchester, Detroit and Silicon Valley.

Coming from a different perspective, Boix provides new-to-me insights, and particularly about similarities between the sucessive technological revolutions. For example, in an 1835 book, The Philosophy of Manufactures, Andrew Ure described the factory as “a vast automaton composed of various mechanical and intellectual organs, acting in uninterrupted concert for the production of a common object, all of them being subordinate to a self-regulated moving force.” Echoes of cybernetic visions – see for example Eden Medina’s fantastically interesting Cybernetic Revolutionaries on Project CyberSyn. Or a 1934 book, The Mechanization of Industry by Harry Jerome, which estimated that almost half the labour productivity gains in the first 30 years of the 20th century resulted from “the mechanization of the handling systems”. Echoes of the role of logistics now, for example set out in the McKinsey’s study into US productivity in the late 1990s – Walmart and wholesaling.

After the historical section, Boix goes on to the implications for politics today, and particularly the increased vote for extremist parties – the highest since the 1930s. Writing this on the day “Boris”Johnson is expected to become the UK’s prime minister, with Donald Trump beginning extra-judicial deportations from the US, and strongmen on the march in other countries, it is hard to be optimistic. However, Boix, like Frey, implicity raises one question without addressing it: what made the production paradigm of the mid-20th century. which also led to massive automation, able to deliver widely shared gains, and why is the direction of the earlier and later technological revolutions so different? I haven’t seen a persuasive answer.

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An Adam Smith for our times

Jesse Norman is one of the most thoughtful of the UK’s MPs, a principled Conservative, and has followed up his earlier biography of his hero Edmund Burke with Adam Smith: What He Thought and Why It Matters. It’s an excellent overview of Smith’s life and work. It would make a terrific read for economics students but also has much to interest those who’ve read every book about Adam Smith going. Like many recent books about Adam Smith (such as Emma Rothschild’s Economic Sentiments and Nicholas Phillipson’s biography An Enlightened Life), it reclaims the Theory of Moral Sentiments as having equal importance to The Wealth of Nations.

Part of Jesse Norman’s aim is to dissociate Smith from the ‘free market’, invisible hand caricature of many conservative economists and thinkers. The first part of the book is a pretty standard biography, nicely done. The second part is a history of how neoclassical economics came to hijack Adam Smith, stripping away from his thinking much of its richness and depth, not only in terms of human behaviour (not narrowly self-interested in Smith) but also in terms of institutional context (dynamic, contingent, evolutionary). The book has a nice section on Vernon Smith, whose experimental work in the 1980s was an early critique of the assumptions of neoclassical general equilibrium theory. In effect, it argues, much of modern neoclassical economics as it peaked in the late 20th century was foreign to Smith’s approach. What Smith did do was: “Set out the field of political economy with markets at its centre,” but in a way that makes institutions and historical sensibility equally central.

(There is also a section on Smith’s strong, principled opposition to the slave trade. It can never be said often enough that economics got the label ‘the dismal science’ from Carlyle because economists were prominent campaigners against slavery.)41Rqw3Bgi4L._SX324_BO1,204,203,200_The book ends with a section on ‘why it matters’ and what a Smithian perspective would be on the economy now. Norman notes the tyranny of the arid mainstream perspective in policy economics right up to the financial crisis (although academic economics had by then already started to move decisively away from free marketism): “What is so striking about that crisis in retrospect is not, even, the egregious self-enrichment of the previous decade, or the specific failures of policy, law and enforcement involved. It is the intellectual grip which the language of free markets held on almost all the parties concerned, regardless of the often very different reality.” Indeed, free marketism still has a strong grip on policy, given that so many policymakers were trained in their economics when it was still at its peak.

What is to be done about this. “We need a new master narrative for our times,” Norman writes (italics his). The book calls for political renewal too. Who could disagree? (Although that makes it disappointing that Jesse Norman declared himself a supporter of Mr Johnson in the current Conservative leadership campaign.) It concludes, of course, that returning to the true Adam Smith can help shape the new narrative with markets still central to economic life but understood in the context of a political economy in which institutions, historical context and human nature play their proper role.

 

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Thinking strategically about platforms

Digital platforms have been very much a focus of policy attention of late, with reports on the problems and challenges they raise published by the UK (several, including the Furman Review), Australia, Germany, European Commission & others. The platforms these various reports discuss are the big ones, and the concerns range from competition policy to employment practices to online harms.

A terrific new book by Michael Cusumano, Annabelle Gawer and Devid Yoffie, The Business of Platforms, points out though that most of the digital platforms that are not big are dead: four in five fail. The book is aimed at people running or starting platforms, offering advice on (as the subtitle puts it). “Strategy in the Age of Digital Competition, Innovation and Power).” The book very nicely links business strategy to the underlying economic characteristics of digital, and I think is probably in this respect the best tech business book since Shaprio and Varian’s (now old, 1998) Information Rules.

It starts by pointing out that there is nothing inevitable about network effects (direct and indirect) kicking in: they have to be nurtured: “Companies and governments have to make the right srategic and policy decisions in order to drive strong network effects.” These can include technical standards, for example, or ensuring competition thrives at the right times and points. The book also distinguishes between two types of platform, requiring different strategies (although there are a groing number of hybrids). Innovation platforms create value by enabling third parties to develop products or service on top of the platform, while transaction platofrms create value by matching different sides of a market.

Key challenges for all, though, involve solving the ‘chicken and egg’ problem (because different sides of the platform depend on each other) by appropriate pricing and cross-subsidy, and figuring out a business model. (And in my view the dependence of so many on advertising is a major weakness & can’t be sustained). The book uses the framework to explore the many platform failures. It also has a chapter on how non-platform incumbents can respond to the digital challenge (it’s tough…), and looks briefly at issues such as the use and governance of data, and also the importance of working with regulators rather than against them and recognizing the responsibilities that come with (market and other) power. “Every major company we cited in this book has been the subjject of government investigations, local regulatory oversight, and intense media scrutiny.”

All in all, highly recommended. If you know the economics, the case studies and management literature covered will be informative, and if you know the business details, the economic framework should be useful. I very much enjoyed reading it.

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