Tim Harford
A man of our times: the frugal Scrooge helped drive down interest rates
Yet another film adaptation of A Christmas Carol has arrived on the big screen. The spirit of Scrooge is alive and well in bookshops this season, too, in the form of Scroogenomics, by the Wharton business school economist Joel Waldfogel. It’s a nicely-timed stocking filler from the man who estimates that badly-chosen Christmas presents will waste the equivalent of $25bn across the world this year.
When I met him in early December, Waldfogel mournfully remarked that the chief impact of his work has been to ensure that he receives very few Christmas presents. But before you abandon whatever present you were planning for the economist in your life, bear in mind that most of us could learn some useful lessons from the dismal science of economics at Christmas.
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Tom Chatfield
"I do not apologise for being correctly quoted"
Speaking at the City Banquet at Mansion House yesterday, FSA chief Adair Turner reflected on his interview last month with Prospect in robust terms, declaring that “I do not apologise for being correctly quoted as saying that while the financial services industry performs many economically vital functions, and will continue to play a large and important role in London’s economy, some financial activities which proliferated over the last ten years were ‘socially useless’, and some parts of the system were swollen beyond their optimal size.”
You can read the full text of his speech online here, and it comes highly recommended as both a summary of Turner’s position and as a riposte to his critics’ suggestions that the social usefulness of economic activities cannot be judged. Such judgements must be made, argues Turner—and this includes a recognition that it is the services banks provide to their customers rather than the money they can make for themselves that are the fundamental justifications for their existence. As Turner puts it: Read more »
Alex Crossman
Above: Adair Turner’s interview in the September issue of Prospect hit the headlines and caused a furore in the City
The City takes too big a share of our economy and is bloated by doubtful profits from dubious activities. Not the allegations of placard-wielding demonstrators but of Adair Turner, chairman of the Financial Services Authority (Prospect, September), and of Lloyd Blankfein, chief executive of Goldman Sachs (to a German banking conference in September), respectively. Suspicion inevitably accrues both to an embattled regulator talking tough and an emollient investment banker. And neither Turner nor Blankfein seems comfortable in their role as Jeremiah. But is either right? Is the City too big?
Britain faces an estimated bill of £130bn for shoring up its banking system, a higher proportion of GDP than any other country. This alone should put the issue of the “right” size of the finance sector on the agenda. Unfortunately, the question yields no easy answer. There is no consensus on a relevant measurement, or even on whether the statistics—especially those in Britain’s national accounts—are reliable. Britain has a historic comparative advantage in finance, so one would expect it to have a relatively larger finance sector than some other countries. No one thinks it odd that Germany has a big car industry.
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Tom Streithorst
Krugman: too easy and too hard on his profession
Reality has a way of destroying elegant theories. This recession has demonstrated the vapidity of most neoclassical economics. It is hard to predict the collapse of the world economy and the destruction of a quarter of its wealth if you start with the assumption that people are rational, utility maximising and omniscient. Back before the bust, even distinguished economists were so infatuated with the Efficient Market theory that they argued bubbles were impossible. If markets always get prices right, bubbles can’t exist. One published a book claiming that the famous Dutch tulip bubble was no bubble at all but rather a rational response to supply and demand.
How did economists get it so wrong? That’s the title of Paul Krugman’s article in this week’s Sunday New York Times magazine and his short explanation is that they forgot Keynes and developed an amour fou for the free market. From Adam Smith until the 1930s, most economists believed that markets were self-regulating. They didn’t look self regulating in the 1930s, with the economy stuck in high unemployment and no prospect of escaping it. Keynes realized that lack of effective demand and unemployment fed on each other, trapping the economy in a low equilibrium state. His solution was for government spending to take up the slack and it seems he was right. It took World War II and the greatest government deficits ever seen to end the Great Depression.
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Tom Streithorst
City limits: the sector must shrink
The outcry at proposals recently floated by FSA chief Lord Turner in Prospect suggests that the City knows they would be effective. The City does not fear “regulation”; regulations can always be circumvented. But a Tobin tax, an infinitesimal levy on all financial transactions, would squash the profitability of much of the short-term trading which swells investment bank profits without doing anything to create value in the real economy.
For the past 30 years, the economics profession has been in the grip of a dangerous delusion, namely that all financial transactions are intrinsically beneficial, in that they create “deeper, more liquid markets.” The credit freeze that began on 9th August 2007 tells us that this liquidity is more apparent than real, that in moments of danger, when markets really need liquidity, it just evaporates. Without the liquidity “fig leaf,” the rationale of social and economic benefits for much trading activity becomes impossible to maintain.
The current financial crisis gives us a chance to return to an earlier understanding of the purpose and function of financial markets. Finance exists in order to most efficiently transform societal savings into productive investment. It is a deal between the present and the future; forgoing consumption now in order to invest in capital goods which will spur productivity, thus allowing greater consumption at a later date.
The explosion in the size and profitability of the financial sector since the early 1980s has almost nothing to do with the creation of capital goods. Real investment as a share of GDP has declined even as financial sector profits have gone through the roof. Arbitrage, intra-day trades, short term purely financial self-referential transactions, which do nothing to create real investment and do nothing for the real economy, would all be priced out of business by a Tobin tax.
The financial sector has grown too big. It needs to shrink. The Tobin tax will do that, without hurting the rest of us. That’s why the bankers are getting apoplectic in the Financial Times. Finance needs to stop being a parasite on the real economy and once again return to its traditional role of creating capital goods and so increasing worker productivity. That is how finance can make all of us richer.
JONATHAN_FORD
Have Britain and the US become banana republics?
Lou Jiwei, the head of China’s sovereign wealth fund, raised a chuckle last December when he called on the World Bank to guarantee investments in the US and Europe, just as it does in developing nations, because investing in those places was no longer safe. But was the sage of Beijing so far wide of the mark to lump America et al in with the ropier emerging markets?
Not according to Simon Johnson, former chief economist of the IMF, who argues in an essay in the Atlantic that America (and by extension, Britain) are becoming like the sort of banana republics the agency so often has to wade in and save. Typically, Johnson observes, emerging market countries “are in a desperate economic situation for one simple reason.”
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