Stumbling and Mumbling

The growth problem

In the economic debate between left and right, there seems to be a shared presumption which I find questionable.
The presumption is that if only we can get the right policies - the right fiscal policy (whatever it is), banking reform, tax and regulatory policy, whatever - then the economy will grow as normal.
I doubt this, on several grounds:
1. Some of the growth since the 1980s came from a rise in households’ debt-income ratios as these adjusted upwards following the relaxation of credit constraints. Although I’m not as convinced as some that consumers are over-indebted, this process is now over.
2. History shows that recoveries from recessions and financial crises are often weak.
3. Gravity works against the UK. We export more to Spain and Italy than we do to all four BRICs.
4. In one important respect, the economy was running out of oomph even before the crisis. In the five years to the peak in 2007Q4, real business investment grew by 4.4% a year. In the previous 20 years - which encompassed a sharp recession, remember - it averaged 5.3% a year.
5. The factors behind this slowdown haven’t disappeared. These include: a realization (thanks to Nordhaus’s research) that investment in innovations is rarely profitable; the migration of low-wage projects to emerging markets; and a slowdown in the rate of monetizable innovations.
The thing is, I’m not sure that there’s much that policy can do about all this. It’s not good enough to “set the private sector free” because it doesn’t want to invest anyway. And it’s not enough to fix the banking system or set up a state bank, because the problem is a lack of demand for credit, not just supply. And “confidence”  is a red herring; the problem is that there is a genuine dearth of investment opportunities, not that firms are unwilling to see them.
If I’m right, or even nearly so, there are implications here for both politics and the markets.
For politics, it suggests the task is not (just) to promote growth - which might not be greatly possible - but to adapt to an era of slower growth.
For the markets, this suggests a fundamental reason for permanently(ish) lower equity valuations: that future growth will be lower. 

Denialism about democracy

In recent days, I’ve seen two examples of denialism about the defects of democracy.
First, a couple of commenters at LibCon have tried to deny my claim that there is a contradiction between libertarianism and democracy. They’re wrong.
Robert Nozick began Anarchy, State and Utopia with the line: “Individuals have rights, and there are things no person or group may do to them.” This, or something like it, surely, is the cornerstone of libertarianism.
But there are often cases where democracies want to infringe those rights.  This can happen under direct democracy, as with the Swiss ban on building minarets, or representative democracy,  as with the French ban on wearing burqas*. In such instances, a libertarian insistence upon protecting rights conflicts with a democrat’s desire to see the will of the people enforced.
There is, therefore - obviously - a conflict between libertarianism and democracy.
Secondly, Rob Marchant describes the governments of Venezuela, Russia, Iran and Gaza as “pseudo democratic.”
I fear that word “pseudo” is serving to hide a nasty fact - that Chavez, Putin, Ahmadinejad and Hamas have all been very popular. Democracy can produce rulers who are bigots, terrorists and tyrants. This is not necessarily because there’s something “pseudo” about the democracy, but because there’s something unpleasant about public opinion.
Granted, you can say that this opinion in these countries is warped by an unfree media or the influence of religious bigots. But public opinion even in what Rob calls “healthy” democracies is also affected by some unpleasant influences.
What I’m saying here should be a trivial Berlinian point, that there can be conflicts between values. The value of democracy can conflict with the values of liberty or even decency.
What worries me is that even intelligent people like Rob seem reluctant to acknowledge this. I fear that democracy has become such a cheer word that people are unwilling to recognize its defects.
But it does have defects. I say this not (just) because I’m a Marxist, but because I’m an economist.
All democracies, pseudo or not, contain bad incentives. Voting is cheap, and thus over-supplied. And people who vote for bad governments or policies do not pay the price of doing so; the cost of bad government falls upon all citizens, not merely (and often not mainly) upon its supporters. Basic economics, then, predicts that democracy will sometimes have unpleasant effects. Which makes it all the odder than so many people are in denial about this.
* The are clear examples of anti-libertarian policies. Any “libertarian” who pretends otherwise is just confirming Flying Rodent’s opinion of them.

Labour shouldn't apologize

“Does Labour need its own tea party?” asks the title of a post by Luke Bozier. I was hoping this would be an argument for some leftists to make extremist arguments, with the intention of shifting the Overton window leftwards.
I was disappointed. Instead, Luke says:

We must begin to admit that we were fiscally irresponsible for years, in order to gain the trust of the public again, at least on the economy.
Not only is it important in order to win elections - fiscal responsibility is the right thing to do.

Now, I’m no fan of Gordon Brown. But if there’s one thing he shouldn’t apologize for, it’s “fiscal irresponsibility.” My chart shows the story*. It shows that the public sector’s financial balance is very largely the mirror image of the corporate sector’s one. This shouldn’t be surprising, because for every borrower there must be a lender, and so across all sectors of the economy (which includes foreigners) net borrowing must be zero. The fiscal deficits of the mid-00s were, then, counterparts of a corporate surplus.
And - I would add - the result of them. Companies’ reluctance to invest meant there was a tendency towards weak economic activity generally, which in turn added to government borrowing.
I say that the causality runs from the corporate surplus to government deficit, rather than vice versa, for two reasons.
First, the 00s were, generally, a time of low and falling real government bond yields. This is the exact opposite of what would have happened if high government borrowing had crowded out corporate spending. It is, though, consistent with a lack of demand to borrow - a lack of investment.
Secondly, the weakness of capital spending was not a UK phenomenon but a global one; back in 2005 Ben Bernanke was worrying that “many advanced economies…face an apparent dearth of domestic investment opportunities.”
Faced with firms’ reluctance to invest, budget deficits were pretty much inevitable. Had Labour tried to be “fiscally responsible” and cut spending or raised taxes, we’d have just had higher unemployment.
Labour, then, shouldn’t apologize for the budget deficits.
Yes, it spent badly. And yes, you could argue that it might have been better to have a mix of tighter fiscal policy and looser monetary policy - though as this would have exacerbated the housing bubble, this is arguable. But the deficits were the least of Labour’s sins.
This said, I’ve nothing against telling lies for political purposes. But I’m not sure a false apology would promote Labour objectives.  In the debased world we live in, “fiscal responsibility” does not mean higher taxes on the rich or a clampdown on the corporate welfare state created by slack procurement policies and addle-brained public-private partnerships. Instead, it means cuts in jobs and benefits.  “Fiscal responsibility“ then, has the precise opposite to what I’d hoped Luke’s post would be about - it serves to shift the Overton window rightwards.
* This should be familiar to regular readers. But as Luke doesn’t address it, it’s clearly not familiar enough.

Self-fulfilling beliefs

The fact that Spanish and Italian bond yields are near 14-year highs matters for a simple reason - market opinion is self-fulfilling. If investors think Spain and Italy will be unable to service their debts, borrowing costs will rise so much that they will indeed be unable to do so.
This is an example of what John Searle called self-referentiality. There are some beliefs which can be true by virtue of enough people believing in them, for example:
- These scraps of  paper in my pocket have value because others believe they have value, and so treat them as money.
- If enough people believe a monetary expansion will lead to higher prices, rather than to increased output, then it will do so, because inflation expectations will rise, and so firms will raise prices in anticipation of others doing so.
- Insofar as the press have power, it is because (some) people believe what they read. One effect of “hackgate” could be reduce the credibility of the press and hence its influence.
Feel free to add other, better, examples.
But here’s my question. Could it be that some aspects of “neo-liberal” economics possess this self-referentiality?
For example, if high earners believe high taxes are unfair, then they are more likely to stop work; no-one likes being ripped off. Or if firms believe that corporate tax cuts stimulate investment, they are more likely to invest if only because they expect other firms to invest and thus increase demand for their products.
The econometrician, looking at the effect of high income taxes or corporate tax cuts, might then infer that they have the effects that neo-liberals predict.
But this is only true because people have neo-liberal beliefs. If they believed that high taxes were a just contribution to society, they’d be less likely to reduce their labour supply. If they thought the effect of taxes on investment was small, firms wouldn’t invest in anticipation of others’ investment, so there’d be no investment boom.
Let’s go further. Imagine we lived in a society described by Joseph Carens in his out-of-print book Equality, Moral Incentives and the Market. In such a society people are egalitarians; they believe their talents do not entitle them to higher than average wages. Carens shows that this can reconcile equality and efficiency. Pre-tax wages are unequal, as now, and (some) folk choose the job that will maximize pre-tax wages on the grounds that doing so maximizes their contribution to society. But the tax system equalizes post-tax wages and no-one much objects because they are egalitarians.
In this society, the neo-liberals’ prediction that redistributive taxes reduce effort is plain wrong - it doesn’t.
So, what is the difference between the neo-liberal society and Carens’ society?
Bone-headed right-wingers will claim that the neo-liberal society is the real one we live in. But this begs the question. It’s possible that - insofar as neo-liberalism is true (and for the purposes of this piece I’m making the massive assumption that it is), it is true only because believing makes it so. If we had Carens-style beliefs, an egalitarian society would be self-fulfilling too.
Which leads me to a thought. Even if the economic “facts” seem to support neo-liberal ideas, this does not suffice to rule out radical change, because those facts might be true only by virtue of a particular set of beliefs. And if these beliefs are malleable in a Carens-ward direction, then  socialism might have validity, even if the facts appear to suggest otherwise. It could be that every word Tim Worstall has written about Richard Murphy is true - and yet irrelevant.

Organizational failure

Steve Randy Waldman has a good critique of Tyler Cowen’s view that the financial crisis is due to a downward revision of overly optimistic estimations of our wealth.
I agree. If the boom had been due to people in general believing they were richer than they were, we’d have seen soaring share prices and a boom in capital spending in the mid-00s, as we did during the tech bubble. But we didn’t. Instead,  as Steve says, the problem was not generalized over-optimism but rather a specific one, confined to banks.
Steve blames this on bad incentives. I’m not sure this is the whole story. For one thing, in the UK at least, it seems that the pay of banks’ bosses was not out of line (pdf) with that of bosses generally, suggesting that, in one respect, there was nothing unusual about bankers’ incentives. And for another, insofar as incentives were wrong, they had been wrong for years. So why did banks collapse in the late 00s, rather than earlier?
Here’s a theory. It’s to do with organizational brittleness. Here are some background principles:
- The death rate for firms generally is high. Of the UK’s biggest employers in 1907, only three are still independent, stock market-listed companies today.
- Companies embody specific vintages of organizational capital. Their expertise depends upon the state of technology when they were formed. It’s rare for a firm to transform itself from one activity to a completely different one; Nokia, which used to be a cable firm, is a rare exception - and a less healthy one than it seemed a few years ago.
- Because organizational capital is fixed, firms have “very limited capacities to acquire knowledge (pdf).” Rather than adapting to new conditions, firms die.
And here’s the thing. Banking changed in the 00s, in such a way as to render the vintage organizational capital of many banks obsolete, and thus to kill them.
Traditionally, banking consisted of getting deposits from savers and lending them to home buyers and companies. But in the 00s, this changed. Savings came not from UK and US households, but from Asians who wanted AAA bonds. This meant that many banks’ traditional business models were useless. They had to use wholesale funding, collateralized against manufactured securities, rather than merely domestic deposits. And this required that, rather than judge credit risk, in which they had some experience, they had to judge liquidity risk - in which, we know now, they were (even) less expert. It is no accident that the two “UK” banks to have done best during the crisis - HSBC and Standard Chartered - happened to be banks whose vintage capital gave them the ability to attract Asian deposits.
The banking crisis, then, was an example of a general corporate problem - the same sort of thing that killed Tower Records, Borders, Polaroid and countless others - an inability to adapt their business model to market and technical change.
I say all this because this story doesn’t fit comfortably into a Keynes vs. Hayek-style debate. It’s awkward for Keynesians because the story here isn’t an orthodox one of market failure, but rather of organizational failure - and a failure of organizations run from the top-down, which is what many statist Keynesians admire.
On the other hand, though, it’s awkward for Hayekians, because the message of the crisis and subsequent recession is that markets - actually existing ones rather than the textbook fairy tales - cannot smoothly absorb the failure of big organizations. 

Pay, groups & decisions

Would lower pay for chief executives improve corporate performance? I’m prompted to ask by a new paper which provides experimental evidence on group vs. individual decision-making. It concludes:

Small groups made better choices than individuals in isolation and substantially reduced the frequency of winner’s curse bids in a company takeover experiment...Groups make better decisions due to a combination of learning and the process of aggregating individual proposals into a group choice.

This has direct implications for corporate governance, because the decision analyzed here - a corporate takeover - is often a major cause of calamitous failure. This evidence suggests that a collegiate board might at least be better at avoiding disaster than boards which are dominated by a powerful CEO.
But what’s this got to do with CEO pay? Plenty. It’s reasonable to suppose that very high CEO pay will be associated with more individualistic decision-making. This could be because such pay is the product of a “superstar CEO” ideology which encourages the CEO to stamp himself on the firm. Or it might be simple gift exchange: even a CEO without an ego might think “If I’m being paid so much, I’ve got to take on the burden of decision-making myself.“ Either way, It could be that lower CEO pay would lead to more group decisions and thus to at least the avoidance of fatal errors.
Sadly, however, the direct empirical evidence here is inconclusive. The consensus seems to be that the link between CEO pay and firm performance is weak or hard (pdf)  to identify (pdf). But this is consistent with offsetting mechanisms.
On the one hand, there’s a simple sorting effect. We’d expect the best CEOs to work in the highest-paying firms and to deliver good firm performance. This points to a positive correlation. On the other hand, mechanisms like the one I have in mind here - or the over-motivation effect - might induce a negative correlation between the two.
If you think this is straightforward, there’s another wrinkle. The paper also found that group decision-making tends to lead to the median opinion of the group being chosen, which implies that the best proposal is unlikely to be selected.
This, in turn, suggests that the question of whether to have a collegiate or CEO-dominated board hinges in part upon the payoffs to decisions. If a single bad decision can bring the firm down, collegiate decision making is best. But if the payoffs to bad decisions are low, and those to the best decisions are high, then more individualistic decision-making might be preferred.

"The public interest"

What is the public interest? I ask because there's a campaign for a public jury to investigate how to regulate banks, the media and “political and corporate life” so as to “put the public interest back into the heart of the system.”
As it stands, this stance is inadequate because the phrase “public interest” is vacuous. I have three problems with it:
1. The phrase has so many conflicting meanings as to be useless. Does it mean Pareto optimality, or the greatest happiness of the greatest number, or the will of the majority, or something else? Any of these conceptions is flawed in itself - the greatest happiness, for example, implies that we should favour unlimited population growth - and conflicts, in principle, with the other.
2. Arrow’s impossibility theorem tells us that, under reasonable assumptions, it is impossible to aggregate individual interests or preferences.
3. Talk of the “public interest” does not help us with the fundamental question of how to choose in the face of trade-offs.
Take banks, for example - because the campaign raises it. There’s a trade-off between a banking system that promotes growth, by lending freely, and one that’s safe and lends only cautiously. Which do we prefer? The very fact that there was no great public demand for lending restrictions in the mid-00s, when everyone wanted to jump onto the housing market bandwagon, tells us that public opinion is not obviously the right arbiter. But what is? The campaign seems to think that the answer is a public jury - which presumably will embody a rational, considered public opinion. But to pretend that this can discern the public interest is to beg the question.
So, am I opposed to the campaign?
No. I think the campaign is not about the public interest at all, but something else.
A clue to what that something else is lies in the fact that the campaigners are worried that “power will fall back into the hands of a small elite.”
And there’s the magic word. What the campaigners want (I hope) is for  working class people to have more power and for bankers, bosses and media moguls to have less.
I’m all in favour of this. But isn’t it a sad indictment of our low level of public discourse - and our squeamishness to discuss power openly - that such a demand has to be disguised by waffle about a meaningless public interest?