Stumbling and Mumbling

In praise of complexity economics

The Economist's ranking of the most influential economists of 2014 has been derided, and Tyler Cowen provides a more sensible list. But I wonder: which economists should be more influential than they are?

The glib answer here is: whoever corroborates my prejudices. A less glib answer would be the countless economists who are doing good work which is insufficiently appreciated by the public: I try to publicise some of this in both here and in my day job.

But there's another answer I'd like to offer: those economists who have been working in the field of complexity economics. Perhaps the pioneer here is Brian Arthur, who has written a great short introduction (pdf) to the subject. But I'd also mention Eric Beinhocker*, Cars Hommes, Alan Kirman and, in financial economics, Andrew Lo, whose theory of adaptive markets I find an attractive alternative to the efficient/inefficient markets hypothesis.

One feature of complexity economics is that recessions can be caused not merely by shocks but rather by interactions between companies. Tens of thousands of firms fail every year. Mostly, these failures don't have macroeconomic significance. But sometimes - as with the Fukushima nuclear power plant or Lehman Brothers - they do. Why the difference? A big part of the answer lies in networks. If a firm is a hub in a tight network, its collapse will cause a fall in output elsewhere. If, however, the network is loose, this will not happen; the loss of the firm is not so critical. Daron Acemoglu has formalized this in an important paper, and there are some good surveys of network economics in the latest JEP.  

The question is: why is complexity economics not more influential?

One reason is that it requires different techniques. It can't be studied merely by problem sets (ugh) devoted to standard optimization techniques. Instead, it requires agent-based simulations (here are a couple of examples), laboratory experiments of the sort done by Charles Noussair among others, or close attention to history and the institutional and cultural settings in which markets operate.

And therein lies a second reason why complexity economics is under-rated. For me, one of its big messages is that context matters. Emergent processes sometimes lead to benign outcomes and sometimes instead to inequality and inefficiency, and which turns out to be the case can hinge on quite small differences. The great economists of the 20th century - such as Keynes, Samuelson or Friedman - tried to offer a general theory. Complexity economics doesn't.

There's a third reason why complexity economics is under-rated. It does not give us a means of foreseeing the future. Of course, conventional economics doesn't do so either. But the difference is that complexity theory tells us that such forecasts might well be impossible - which is not what the customer wants to hear. The best it can do is help us understand what has happened. And for me, this is good enough. As someone once said, "Economists have only changed the world; the point, however, is to understand it."

* The Origin of Wealth is like Marx's Capital or Kahneman's Thinking Fast and Slow; it gets a lot better once you get past the first 50 pages or so.

The diversity paradox

Listening to Lenny Henry on the Today programme this morning, I was reminded of a paradox about diversity.

What I mean is that there are (at least) three distinct meanings of the term. One is ethnic and gender diversity - ensuring that women and minorities are fairly represented in positions of power and prominence. A second is cognitive diversity - giving space to different intellectual perspectives. And a third is ecological diversity: having a variety of strategies and business models.

I would argue very strongly for diversity in the last two senses.A multiplicity of perspectives - or epistemological anarchism in Paul Feyerabend's words - can be a solution to the problems of (tightly) bounded knowledge and rationality; this is expressed mathematically in the diversity trumps ability theorem. And ecological diversity can protect economies from shocks: the 2008 crisis was so severe because there was a lack of such diversity in the financial sector because many banks were following similar strategies. In a changing environment, mixed strategies help ensure survival.

A big reason why I support gender and ethnic diversity is because I favour these other forms of diversity. There's evidence that ethnic diversity can promote innovation and productivity, probably because it contributes to diversity in these other senses.

Which brings me to my paradox. My support for all three types of diversity is, I fear, not widely shared. Quite the opposite. Whilst there is widespread support in words (if not deeds!) for ethnic diversity, some of the dominant trends of our time are working against diversity in the other senses. For example:

 - The main political parties have become more homogenous in the sense both of squeezing out mavericks and in the sense of becoming increasingly dominated by career politicians to the exclusion of people from working class backgrounds.

 - Managerialists' attempts to impose hierarchy and targets onto all organizations are an attack upon ecological diversity.

 - Social media might have exacerbated the trend towards groupthink, in which dissonant views are shouted down.

 - There's a variety of perfectly coherent views which are far less heard than their merits would warrant: Oakeshottian conservativism, small state Keynesianism, left Hayekianism and so on.

Such conflicting attitudes to the different concepts of diversity are evident on the Left. Lefties have been happy to call for more ethnic diversity whilst fiercely opposing free schools - though the latter, insofar as they have merit at all, are an example of ecological diversity.

Not that the vice is confined to the left. I suspect that those "socially responsible" bosses who want to promote women and minorities in their firm often do so by hiring those who think just like them - thus achieving ethnic diversity at the expense of cognitive diversity.

All this brings me to a variant of the question asked by Nkem Ifejika: what's the point of having so many ethnic minorities in positions of power and prominence if nothing else changes?

Mr Henry replied that doing so would level the playing field. That's reasonable insofar as it goes. But given that equal opportunity and social mobility are such weak ideals, I fear that it grossly undersells the potential benefits of diversity.      

The fiscal-monetary mix

In my previous post, I pointed out that, given the inflation target, a less tight fiscal policy implies higher official interest rates. This means that the choice between the two main parties isn't just about fiscal policy, but about the fiscal-monetary mix: Labour offers looser fiscal and tighter* money than the Tories. Which poses the question: what should be the right mix?

Simon is, of course, right:

It is stupid to commit to further significant fiscal contraction (‘austerity’) when interest rates are still at or close to their lower bound. It means we become more vulnerable to adverse shocks to demand.

Let's suppose, however, that the OBR's forecasts are right and that the economy can grow decently and that inflation will rise even with a tight fiscal policy: this is, of course, a strong assumption as economies are inherently unforecastable. If this is the case, we might well be pulling away from the zero bound midway through the next parliament; markets are pricing in a 1.5% Bank rate by 2017.

Which poses the question: what should be the policy mix then? If we could achieve the same growth and inflation with different fiscal-monetary mixes, which mix should we prefer?

The argument for fiscal tightness is straightforward. We need to stabilize or reduce the debt-GDP ratio sometime. Intergenerational equity counts for something, and there's a risk that global real interest rates will trend up, adding to debt service costs. There's also a case for raising real interest rates: a long period of low rates risks creating a social norm against saving.

There are, though, three issues here.

1. Inequality. For a given level of unemployment, loose money and tight fiscal policy might generate more inequality. This is because loose money raises the prices of assets, which are - by definition - held by the rich. Also, the burden of fiscal austerity is likely to fall upon welfare claimants. (Yes, many of the poor are in debt - but the interest rates they pay aren't related to Bank rate.)

This, though, isn't a knockdown argument. If a loose money/tight fiscal mix does have adverse effects on equality, the solution lies in changing taxes and benefits - not necessarily in altering the policy mix.

2. Secular stagnation. If low interest rates stimulate productive capital spending, they are to be welcomed. However, if there's a dearth of monetizable investment opportunities, low rates might instead fuel bubbles and malinvestments. In such a world, looser fiscal policy might be preferred precisely because it would crowd out the private sector.

Again, though, it's not clear how relevant this is. On the one hand, the housing market seems to be cooling and the stock market isn't in a bubble: if it were, I'd have retired by now. But on the other hand, the fact that business investment fell in Q3 suggests that real investment opportunities might still be limited.

3. Practicality. One argument against a sharp tightening is that it implies cuts in public spending which are too big to be credible. A slower pace of cuts would have the virtue of giving the government time to research ways of improving efficiency; make the organizational changes which could deliver services more cheaply; and create more of a political consensus on which functions the state should relinquish.

Now, I don't have especially strong views here. Which is my point. The best fiscal/monetary mix depends upon the context. As Edmund Burke said:

Circumstances (which with some gentlemen pass for nothing) give in reality to every political principle its distinguishing colour and discriminating effect.

I can easily imagine circumstances in which I would be on the side of some sort of fiscal austerity; my opposition to austerity so far has been because the circumstances aren't right for it.

I fear, though, that my view is a minority one and that many others' positions (on both sides) are more fixed. But then, that's the thing about us Marxists - we are so much less dogmatic than others.  

* By tighter money, I mean a higher real Bank rate. I find arguments about the definition of "tight" money tiresome.

Deficits & interest rates

I fear that the argument between Robert Peston on the one hand and Simon, Paul and Alex on the other about the relationship between government borrowing and interest rates is understating something important.

I agree with Robert's critics that interest rates are not determined by bond vigilantes or confidence fairies - at least for the UK at current debt levels. But there is a different reason to think that a looser fiscal policy would lead to higher rates.

Quite simply, looser fiscal policy would lead to higher aggregate demand and hence to a smaller output gap. If you believe - as the Bank of England does - that a smaller output gap leads to more inflation (or at least the risk thereof) then this means higher interest rates will be needed to hit the inflation target. And because gilt yields should be equal to the expected path of future short rates, it follows that a looser deficit should mean higher yields.

Paradoxically, the more Keynesian you are, the more you should accept this. If you think fiscal multipliers are very big, then looser fiscal policy means much bigger aggregate demand and hence - given the Bank's remit* and view of the inflation process - significantly higher rates.

In this sense, the choice is not just about fiscal policy but about the fiscal-monetary mix. Labour is offering looser fiscal and tighter money than the Tories.

In this context, David Cameron said something yesterday that's misleading. It's this:

By 2018 we will be putting money aside so that if any crash or shock happens to our economy, we will be better prepared.

Now, it might be that a tighter fiscal policy now would give us more room for fiscal manoeuvre when the next recession hits. But the counterpart of a tighter fiscal policy is that interest rates will stay close to the zero bound - which will give us less room for monetary manoeuvre in future. It's not obvious which is best.

One could easily argue - though I'll save this for another day - that a looser fiscal/tighter money policy is preferable. It's entirely coherent to say: "Interest rates would be higher under a Labour government - and a damned good thing too."

Herein, though, lies a puzzle. If Labour's policy implies higher interest rates, why aren't we seeing more volatility in gilts as market opinion about the election outcome varies?

One possibility is that there won't in reality be much difference between the two parties' fiscal policies simply because the Tories' stated plans are nonsense: four-fifths of macroeconomists agree with Rick that their spending plans are in la-la land.

Another possibility is that interest rates won't rise much whoever controls fiscal policy, as they'll be held down by some combination of secular stagnation, deflation and stagnation in the euro area and (very arguably) falling oil prices.

These two possibilities hint at something else - that perhaps the debate about the impact of the deficit upon interest rates isn't very important for practical purposes.

* Those who argue for a serious reflationary policy should be calling not just for looser fiscal policy but for a change to the inflation target too (and of course many are).

Another thing: Robert's "fey anthropomorphism" of the market is mistaken. The "Mr Market" metaphor can sometimes be horribly misleading. 

Political illiteracy

Alex is right:

The debate over the economy occurring within the Westminster bubble may now have become completely detached from anything that is happening in what the rest of us would recognise as the economy...The everyday “reality” as it is experienced by the rest of us has ceased to be relevant to the debate.

But I wonder: is the problem here merely one of economic illiteracy, or is it also one of political illiteracy too?

Here's what I mean.

The reason why many of us fear that deficit reduction is infeasible lies in the paradox of thrift; if enough people try to reduce their borrowing at the same time, the result isn't lower borrowing, but lower incomes.

This paradox, though, is a particular example of a general problem - that, sometimes, individuals' plans are incompatible: we can't all achieve what we want, even if each of those plans is reasonable in isolation.

It is this problem that makes politics necessary: politics is what happens when I want a quiet night in and you want a party.

However, there is a widespread failure to appreciate this. There is, as I've complained, a blindness to the problems of collective action. Such imbecility reached its apogee in 2012, when David Cameron said, during the threat of a tanker drivers' strike: “If there is an opportunity to top up your tank if a strike is potentially on the way, then it is a sensible thing if you are able to do that.” This failed to see that what was sensible for any individual would merely have led to queues, panic buying and shortages if everyone did it.

It would, however, be unfair to blame the Tories alone for this. In the public mind also, politics has ceased to be a matter of organizing our affairs to minimize conflicts and become a narcissistic display of self-righteousness. And of course, in the media politics has always been about Nick Robinson-type Kremlinology of who's up and who's down as much as about fundamental political questions.

This, I suspect, explains why Cameron's talk about the "nation's credit card" has been accepted by voters and the media: people can see that it's feasible for them as individuals to pay off their credit card, but don't see that it might not be so easy for an agent as big as the state to do so.

It also explains something else. All of us who have both brains and hearts knowthat our biggest economic problem is not the deficit but falling real wages and (not unrelatedly) mass unemployment.

However, in an age of narcissisism, this problem has become individualized: "You want a job? Look for one." "You want a pay rise? Get a better job." This is, of course, embodied in government policy aimed at making work pay.

The error in this approach is obvious once we ask the foundational political question: are plans compatible? Of course, any individual might well be able to improve their lot by better job search. But if we all did so the result would be merely falling wages (at least temporarily) as labour supply increased and frustration because the demand for labour falls well short of supply.

In this sense, therefore, the elevation of "the deficit" over the problem of low pay is not just economic illiteracy but political illiteracy too - a failure to see that is politics is (or should be) really about how to arrange affairs so as to make individuals' reasonable plans as compatible as possible.

This is one reason why economists such as me, Simon and Paul Krugman (I apologise for putting myself into such elevated company) are drawn into politics. It's because our economic problem is a fundamentally political problem - and people have forgotten what politics is. 

Miliband's illusion of control

One of the oldest and best-attested cognitive biases is the illusion of control - our tendency to over-estimate our ability to control events.Ed Miliband's speech on the deficit was an example of this bias.

He omitted to state what should be obvious, that the government is not in control of the public finances; if it were, the errors in borrowing forecasts, even in times of economic stability, would not have been as huge as they have been. Instead, the government can only reduce its net borrowing if the rest of the economy - households, companies and foreigners - want to reduce their net lending. If they want to continue to run a financial surplus (that is, save more than they invest) then attempts by the government to reduce borrowing by cutting spending will merely lead to lower output, not to less borrowing.This is the paradox of thrift.

Now, maybe the rest of the world's financial surplus will decline in coming years, which would allow the government to reduce its deficit. Maybe lower oil prices will unleash a wave of capital spending around the world and more corporate borrowing. Maybe UK households will get into more debt as the OBR expects. And maybe the process of balance sheet repair in the euro area is almost over, and so borrowing will resume.

Or maybe not. We can't say.

But Miliband ignored all this basic economics, and perpetuated the error that politicians are in charge of events.

You might object that he came close to recognising the truth when he said that deficit reduction requires a higher-wage economy.

Close - but not close enough. Higher wages would reduce government borrowing if they raise aggregate demand - if workers spend their higher incomes whilst the drop in profit margins doesn't deter capital spending. If, however, workers use their higher wages to pay off debt, whilst firms respond to lower margins by cutting capital spending, then aggregate demand will fall, the private sector will run a financial surplus and the public finances will remain in deficit.

A high-wage economy would only cut the deficit if wage-led growth is a viable strategy. This might or might not be the case - but Miliband didn't make it today.

In this sense, his speech is bad economics.

There is, however, a defence of it. For one thing, his pledge to run a surplus on the current budget "as soon as possible" might be an acknowledgment that it won't be possible.

And for another, politics is not economics. The media (and perhaps voters) don't want economic expertise. They want someone who appears to be in charge of events.As I've said, in the hyperreal economy, the point is not to reduce the deficit but to appear to reduce it.

If Miliband is playing along with "mediamacro", I'll applaud him. My fear is that if a man feigns madness for any length of time, he eventually becomes genuinely mad.

For worker control

Neal Lawson is absolutely right. Social democracy is "hopelessly prepared for the 21st century."

This is because it is yet another example of an idea that has outlived its usefulness. Social democrats used to think that they did not need to challenge the fundamental power structures of capitalism because, with a few good top-down economic and social policies, capitalism could be made to deliver increased benefits for workers and the poor in terms both of rising real wages and better public services.

But Neal is right. The "golden era" in which this was true has vanished. Instead, we face harsher times. Secular stagnation means real incomes mightn't grow much. Globalized (pdf) labour markets and mass unemployment might exacerbate the effect of this in depressing real wages. Job polarization and the degradation of once-good jobs means workers face deteriorating job quality. And (self-imposed) austerity means that what economic growth we do get won't translate into better public services.

Times have changed. So the left must change. Neal says:

Instead of pulling policy levers, the job is to create the platforms so that people can collectively change things for themselves.

There's one context in which this is especially necessary - the workplace.

Put it this way. Back in the late 90s, many internet startups weren't generating the cash to pay staff well. So instead they offered equity stakes. Their thinking was simple, and correct: if you can't offer money, at least offer hope. The same should be true today. If firms cannot or will not offer rising wages, they should at least offer non-pecuniary benefits: more control over working conditions and the assurance of good rewards if the business thrives in future. There are (at least) three big benefits to doing so:

 - Increased power for workers directly raises their well-being. People don't just care about what they get, but how they get it. Processes in which they have a say are better than ones in which they don't. What's more, the quality of one's boss is a huge influence upon job satisfaction. This points to a case for workers choosing their bosses, to increase the chances of them getting good ones.

 - There's a good (pdf) body of evidence (pdf) to show (pdf) that worker (pdf) ownership and control can raise productivity. Such a view should not be a leftist one. Econ 101 says that if workers have a stake in the firm being a success - in the form of a profit share rather than flat wage - they'll have more incentive to do well. And Hayek pointed out that central planning was impossible because people at the top of hierarchies couldn't know enough. That's an argument for using the dispersed knowledge of workers.

 - A feeling of control at work might have favourable cultural effects. One reason for dissatisfaction with conventional politics is that people feel alienated from the political process - which shouldn't be surprising because conventional politics has been about what "they" do to/for "us." If, however, people acquire more control and agency in one sphere of their life, they might want to acquire it in others. This could eventually improve the quality of our democracy generally. As Tocqueville said, democracy "spreads throughout the body social a restless activity, superabundant force, and energy never found elsewhere, which, however little favoured by circumstance, can do wonders."  

Of course, there are countless types and degrees of worker ownership and control, some compatible with capitalism and some not. But this is a strength, not a weakness.

My point here is a simple one. The days when the leftist politics could ignore the "hidden abode of production" because lightly modified capitalism would deliver the goods have gone. Our new times require new politics. The fact that the Labour party is ignoring the question (pdf) of how to empower workers is lousy politics as well as lousy economics.

Inequality & productivity

Ryan Bourne said this morning on Twitter:

Inequality puff pieces and junk papers just can't answer a simple question: how does a larger gap of outturn income reduce productivity growth?

Here are some possible mechanisms.

1. Inequality might demotivate poorer-paid employees because they look to star employees and bosses to help the firm rather than take the initiative themselves. One study of Italian football teams has found that "high pay dispersion has a detrimental impact on team performance." This is consistent with Jeffrey Nielsen's argument that leader-based organizations cause an under-utilization of employees' abilities.

2. Wage inequality reduces (pdf) job satisfaction. And less happy workers tend to be less productive.

3. Inequality reduces trust. As Eric Uslaner and Mitchell Brown have written (pdf):

Economic inequality leads to less trust in two ways. First, high levels of inequality lead to less optimism for the future. Greater pessimism means less trust. Second, where there is a lot of inequality, people in different economic strata will be less likely to have a sense of shared fate.

There's strong evidence that low trust leads to lower growth. One reason for this is that trust helps to overcome "markets for lemons"-type problems of asymmetric information. As Deirdre McCloskey wrote: "business normally depends on a state of trust not on explicit contracts."

4. Where inequality is high, the rich will invest (pdf) a lot in simply protecting their privilege - for example in intellectual property protection, police, security guards, lawyers and so on. This diverts resources away from productive use. Stephen Magee shows (pdf) that there's a hump-shaped relationship between the number of lawyers in a country and economic growth - and the unequal US has too many lawyers.    

5. At high levels of inequality, the rich might fear that property rights are insecure - because they might fear revolution, a harshly redistibutive backlash or simply theft. This deters investment. As Ronald Beanbou wrote (pdf): "inequality exacerbates social conflict, which in turn makes property rights less secure and reduces growth."

6. Inequality can prevent a shift to more productive organizational forms. There's reasonable evidence to suggest that worker coops can be at least as productive as their hierarchical counterparts. Which poses the question: why aren't there more of them? One reason lies in inequality. Poor workers lack the access to credit that would allow them to buy their firms. And even if they had such credit, they might not want to own the firm simply because doing so is risky; it entails putting all one's eggs into one basket. In a more egalitarian economy, these problems could be smaller.

Now, these mechanisms - many of which are discussed more expertly in Sam Bowles'  The New Economics of Inequality and Redistribution - will vary in strength from time to time and place to place. And no doubt, Ryan can think of potentially offsetting ones.

But there's one big fact which hints that they might be significant. Productivity growth has been much lower recently than it was in the 80s. This should be puzzling to people like Ryan, because for years they've told us that Thatcherite reforms in the 80s should have boosted productivity  growth. So why has it fallen? Might it be that the benefits of those reforms have been offset by the fact that the increased proportion of income going to the 1% depressed productivity through the above mechanisms?

I can't prove this to Ryan's satisfaction. But shouldn't we at least take the possibility seriously?   

Against competition

"How Darwinian should an economy be?" asks Gilles Saint-Paul.

Econ 101 says: maximally so. If competition is fierce only efficient firms will survive and so we'll achieve an optimum allocation of resources. That's the first theorem of welfare economics.

However, there's an assumption here - that the environment is stable, so that firms that are maximally adapted to their environment yesterday will be maximally adapted today. But this might not be the case, says Professor Saint-Paul. If the enviroment keeps changing, firms that were optimal yesterday won't be optimal today. If this is the case, then fierce competition and strong Darwinian selection will give us instability but not optimality. He says:

If selection is too extreme in the current environment, the firms that are best adapted to a given future environmental change, yet performing poorly in present circumstances, will be very scarce, and it will take longer for the economy to produce a large number of such firms in the new environment.

He gives the example of a cobweb cycle. Low wages will select in favour of labour-intensive firms, but this will lead to higher labour demand and rising wages which select against labour intensive firms. Thus we get a boom-bust cycle of inflation and deflation.

But we don't need theory to see his point. We only need to remember the financial crisis. In the good times, Darwinian selection (in terms of pressures upon CEOs rather than selecting firms) favoured banks who borrowed in wholesale markets and invested in mortgage derivatives. As Citi's Charles Prince said: “As long as the music is playing, you’ve got to get up and dance.” But when the environment changed, such strategies were disastrous. Banks that were well adapted to an environment of high liquidity were wiped out when the environment changed.

In this sense, says Saint-Paul, there can be a trade-off between optimality and stability; strong competition and selection gives us optimality as long as the environment stays the same, but also volatility when it changes. How severe this is will, he says, depend among other things upon the size and persistence of shocks.

I'd add that it also depends upon the nature of networks between firms. The collapse of a few banks had catastrophic effects because these were hubs with tight interconnections with both other banks and non-banks dependent upon credit. By contrast, the failure of (say) Phones4U earlier this year had no macro effects because it was part of a looser network. As Haldane and May said (pdf), "disassociative structures are likely to support a larger number of coexisting banks, and can make the network more robust to random losses."

You might think this trade-off can be mitigated by good management: if managers can see shocks coming they can adapt in advance. In the real world though, this might not be possible; as Ormerod and Rosewell pointed out in 2006, "firms have very limited capacities to acquire knowledge about the true impact of their strategies" - a claim corroborated by the banking crisis.

The point of all this is not necessarily to argue for state direction of the economy. If bosses can't know much, nor perhaps can governments: Orgel's second rule says that "Evolution is cleverer than you are."

Instead, it is perhaps to defend the real world in which market forces don't select very strongly. As Nick Bloom and colleagues have shown, there is a large variation in corporate efficiency around the world. From a conventional point of view, this is sub-optimal. But from a Darwinian point of view, it might not be. As Andrew Lo says, what look like suboptimal strategies might in fact be second-best adaptations which permit survival in a changing environment. And the same lack of selection that allows inefficient firms to survive also supports a diversity of firms which stabilizes the economy in the face of shocks.

We know that cognitive and cultural diversity are good things. So too is ecological diversity.

Implausible cuts

I have been watching Chancellors professionally for 25 years. During this time I've seen Budgets and Autumn Statements cheered and jeered by economists. But never have I known one to be greeted with as much incredulity as Osborne's effort on Wednesday. I've had numerous emails from City economists expressing the same sentiments as Stephanie Flanders and Rick - that his spending projections are "probably impossible" and in "la-la land".

This raises the question: what the hell is he playing at?

I think we can discount the possibility that he's laying a trap for the next Labour government - that when Labour tears up his projections they'll be accused of being soft on the deficit.

I don't believe this for two reasons. One is that politicians, being overconfident, rarely plan on being defeated. The other is that there can be no discredit in recognizing the impossible. A man cannot be blamed for cancelling plans to build a unicorn farm.

Another possibility is that he's setting a big hairy audacious goal - that he is, in fact, serious about cutting spending.

If he is, he's going about it in an astonishingly stupid manner. When James Collins coined the phrase BHAG he intended it to be a way of catalysing change. A BHAG is supposed to inspire people to think bigger, to ask how the goal can be achieved.

But this isn't happening. As I've said, Osborne hasn't prepared the ideological ground for a small state. And he's not making the organizational changes that small government requires. Quite the opposite. At least one government department - the Home Office - is acting as if we're in an era of ever-bigger government. He is ducking the challenge made by the IFS's Paul Johnson:

It is surely incumbent upon anyone set on taking the size of the state to its smallest in many generations to tell us what that means.How will these cuts be implemented? What will local government, the defence force, the transport system, look like in this world? Is this a fundamental reimagining of the role of the state?

If Osborne is serious, then his plans are mere cargo cult management, by which I mean this:

Step 1: Announce a target
Step 2: Magic!!!
Step 3: Target met

In this sense, what Nye Bevan said of Anthony Eden applies, mutatis mutandis, to Osborne: "if he is sincere in what he is saying, and he may be, then he is too stupid to be Chancellor."

There is, though, a third possibility, suggested by Stephanie. If you want to promise to return the Budget to surplus in the absence of strong economic growth whilst also holding out the hope of tax cuts, then as a matter of simple maths cuts of the size Osborne envisages are the only option.

But perhaps he doesn't intend to implement these cuts. Instead, he is merely promising to do so to appear tough and "in control of the public finances". And some political reporters are gullible enough to believe him. In the hyperreal economy, the point is not to reduce the deficit but to appear to reduce it. Maybe he's just following Machiavelli:

It is unnecessary for a prince to have all the good qualities...but it is very necessary to appear to have them.