From clipping the wings of the property market to re-assessing the place of the banks, our big brains nominate one lesson they wish their colleagues would learnby Prospect Team / April 14, 2018 / Leave a comment
Published in May 2018 issue of Prospect Magazine
Larry Summers: Get to grips with vicious cycles
The central lesson of 21st century economic experience is that modern economies are not self-equilibrating systems. Indeed, modern economies are often dominated by positive feedback effects that destabilise. Margin calls, bank runs, portfolio insurance, option hedging all cause more selling of assets as their values go down. When selling causes lower prices, which cause more selling, the market mechanism is in trouble. We now understand how it can give way to long-term economic problems such as secular stagnation, where excessive saving drags down demand and economic growth slows.
The challenge is to prevent vicious cycles from developing and to contain them when they start. This will mean more, smarter government policy, not a retreat into market fundamentalism.
Larry Summers, former US Treasury Secretary
Deirdre McCloskey: Cheer up
Don’t believe the gloomsters claiming that the sky is falling, and that we are doomed to stagnation. No it isn’t, and no we aren’t. The gloom produces policies of zero sum, protecting what we have. But the recent history tells of spectacular positive sums. China and India produce riches and engineers at astonishing rates. Wages in the old rich countries are said to be stuck, but they’ve actually kept rising, once allowance is made for the immense r ise in the quality of goods and services.
As for the robots taking our jobs, since modern growth got going—around the year 1800—technological unemployment has never happened, so don’t believe that some half-understood phantom of artificial intelligence is going to put you out on the streets. Be of good cheer. Since 1800, real income has increased 3,000 per cent in many countries, and soon the world. Let it happen.
Deirdre McCloskey, Distinguished Professor of Economics, History, English, and Communication at the University of Illinois at Chicago
Martin Wolf: Pathology, prophylactics and palliatives
Macroeconomics needs to grapple with three linked questions. First, what causes financial crises? Second, what policies would best reduce the risks of such crises? Third, what should the policy response be to crises once they have happened?
On the first, how should we understand the interaction between the financial and monetary systems and the real economy? Sometimes the economy seems to depend on a combination of asset-price bubbles with the unsustainably rapid growth of debt. Why should this be so? On the second, are there more sustainable ways to generate demand? Might redistribution of income towards spenders be the answer? What role can government spending play?
On the third, are there alternatives to a combination of heavy government borrowing with supportive monetary policy? This combination has brought recovery. But the indebtedness built up before the crisis has, in part, just shifted onto the public sector. Moreover, even the private sector’s deleveraging has been modest. Economies remain fragile. Macroeconomics is, alas, not healthy.
Martin Wolf, FT’s chief economics commentator
Robert Gordon: Technology isn’t working
While we often hear that rising inequality is the greatest problem facing western economies, in the long run a greater problem is slow productivity growth. The slow rate of increase in the amount businesses can produce per worker accounts for wage stagnation and the growing fiscal burden of welfare payments, relative to the economy’s ability to raise taxes to pay for these entitlements.
In the US, compare annual productivity growth in the past seven years of 0.5 per cent with the 2.8 per cent over the 50 years between 1920 and 1970. What is the difference? The middle five decades of the twentieth century benefitted from an amazing multiplicity of great inventions—electricity and all it made possible, the internal combustion engine that replaced the horse with motor vehicles and air transport, and the whole realm of entertainment and communication inventions, such as the telephone, phonograph, radio, motion pictures, and TV.
In comparison, computers and the internet boosted productivity growth only briefly in 1996-2004, but since that era, in which paper and file cabinets were replaced by flat screens, search engines, and the internet, business methods have seen little further progress. So far, robots and artificial intelligence have made little difference in the daily lives of workers and consumers.
Robert Gordon is a professor of Social Sciences at Northwestern
Ruth Lea: Know what you don’t know
The economics “establishment,” including the Treasury, the Bank of England and the IMF, were utterly wrong-footed by our economic performance after the Brexit vote in June 2016. Their apocalyptic warnings of a Brexit vote (never mind actual Brexit) were grossly misleading.
The moral of all this is that we should see economic analysis, and economic forecasting, as more art than science, depending on imperfect models of complex systems. Of course, economics should attempt to improve its record on these matters. But, above all, it should learn some humility.
Ruth Lea, Economic Adviser at Arbuthnot Banking Group
Jagdish Bhagwati: Fight for free trade
The big lessons economics needs to grapple with over the next decade is about globalisation. The freeing of trade and looser restrictions on multinational investments have demonstrably been beneficial. Unfortunately, it has brought triumphalism and complacency.
In the late 1980s and early 90s, trade was not a priority for many economists. It could look after itself, they assumed and attention was trained predominantly on macroeconomic issues. But now, protectionism in the United States cuts across both parties—Democratic leaders have been tough on Japan, China, and India, and President Trump has fired the opening shots in a trade war with China.
Trade economists must take up arms. They must enter the policy space with a renewed urgency, to fight for freer trade and for multilateralism, so that they do not end up losing the one sure-fire recipe for improving our welfare.
Jagdish Bhagwati, Professor of economics and law at Columbia University
Ann Pettifor: Grasp that there can never be a market in money
Unlike the prices of bitcoins or gold, the price of money is not determined by the market forces of supply and demand. That’s because money is not a commodity, but a social construct: “a promise to pay” to quote Joseph Schumpeter. So money’s price—the rate of interest—is fixed not by the market, but by lenders and risk-assessors in the back offices of banks. These are in turn influenced by the decisions of men and women on central bank committees.
Because money is a social construct, it can never, like gold, become scarce. In other words, commodities may be subject to market forces, but “promises to pay” are not.
Crises occur when “promises to pay” are not regulated: when money is lent at high rates of interest to risky borrowers (think sub-primers) for speculative, not productive investments. These may fail to generate streams of income (for repayment), and so levels of debt and defaults rise.
That is why, as Keynes argued, the creation of the social construct that is money or credit should be carefully regulated, and not left to “the invisible hand.”
Ann Pettifor, Director of Policy Research in Macroeconomics
Barry Eichengreen: Get to work on jobs
The global crisis and populist backlash laid bare the fact that American “blue-collar workers” had been left behind by technology and globalisation. President Trump promises to rescue them by “making coal great again” and taxing steel imports. We need a better way.
The conventional wisdom used to be that if manufacturing jobs can’t be recaptured from robots and China, then the solution is better service-sectors jobs—jobs that were presumed to be safe from automation and import competition because they require situational adaptability, interpersonal skills and oral communication. But now advances in artificial intelligence raise questions about the future of even those jobs.
Still, jobs requiring workers to combine practical services, communication and empathy—care workers, for example—should remain safe for the foreseeable future. So the pressing question becomes how to better prepare workers for these particular tasks. This requires rethinking education, training and the nature of work itself—a process that has only just begun.
Barry Eichengreen, University of California, Berkeley
Jim O’Neill: Learn to learn from China
The presumption used to be that China would have to learn from the west if it wanted to keep developing, especially when it comes to the political system. But 20 per cent of the Chinese now pull in a western-style income of $40,000-plus per year—that’s 260m people living on western-style incomes, far more than in any actual western country except the US. So the question becomes: what can we learn from China?
In addition to detailed areas like maths tuition (where the UK is already running pilots based on the best Chinese schools) two big areas stand out. First, when it comes to big changes, we should ensure everyone is informed and prepared; the circumstances of the EU referendum is the kind of thing that makes Beijing doubt the wisdom of western-style democracy.
And then there is macro-economic policy. For at least 20 years, Beijing has shown it can head off problems, and deal with crises. Western experts have repeatedly predicted a UK-style housing bubble-and-burst for China, but its authorities have pricked bubbles before they grew too big. Bankers and hedge funds bemoan how hard it is to predict what Chinese policymakers will do next. But the Chinese authorities see their role as being to fix real problems, not to provide clarity to market participants.
Jim O’Neill, former government minister and fund manager
Adair Turner: Clip property’s wings
In an automated economy, without intervention, the rewards are inevitably concentrated in various forms of rent—especially for those who own land in urban centres, technologies that benefit from network effects (Google, Facebook) and inventions. All of these things are concentrated in relatively few hands, fuelling the income gap.
So far, we’ve left land as a free-for-all, greatly benefiting its holders, and increased the advantages of those with intellectual property, for example by extending copyrights for decades after an artist has died. If we’re serious about inequality, we need to change course; economics should concentrate on devising new, smart taxes and regulations to put property back in its place.
Adair Turner, Chairman of the Institute for New Economic Thinking
Brad DeLong: Learn to prevent—we’re out of cure
The crisis and its aftermath showed that the North Atlantic economies could not maintain full employment by following the Keynesian road. The idea that when the private sector sits down the public sector should stand up—that consistent durable prosperity can be achieved by having government step in as a spender of last resort—proved unsustainable. It also showed that full employment could not be maintained by following the monetarist road: the idea that successful regulation could keep finance on a sound footing, or at least a steady enough footing for central banks to manage, also proved unsustainable.
Ultimately prosperity is unlikely to be maintained without competent democratic government, and that has proven shaky since the slump. The big question is: what institutional—and perhaps political—changes are necessary to avoid another wild swing? In all likelihood we’ve only a decade to build better institutions of economic management. And we have not yet begun.
Brad DeLong is at University of California, Berkeley
John Kay: Embrace radical uncertainty
Between 1920 and 1950, a debate took place which defined the future of economics in the second half of the 20th century. On one side were John Maynard Keynes and Frank Knight; on the other, Frank Ramsey and Jimmie Savage.
Knight and Keynes believed in the ubiquity of “radical uncertainty”. Not only did we not know what was going to happen, we had a very limited ability to even describe the things that might happen. They distinguished risk, which could be described with the aid of probabilities, from real uncertainty—which could not. In Knight’s world, such uncertainties gave rise to the profit opportunities which were the dynamic of a capitalist economy. Keynes saw these uncertainties as at the root of the inevitable instability in such economies.
Their opponents insisted instead that all uncertainties could be described probabilistically. And their opponents won, not least because their probabilistic world was convenient: it could be described axiomatically and mathematically.
It is difficult to exaggerate the practical consequence of the outcome of that technical argument. To acknowledge the role of radical uncertainty is to knock away the foundations of finance theory and much modern macroeconomics. But the reigning consensus is beset with glaring weaknesses. Keynes and Knight were right, and their opponents wrong. And recognition of that is a necessary preliminary to the rebuilding of a more relevant economic theory.
John Kay and Mervyn King are writing a book on “radical uncertainty” to be published in 2019
Tim Congdon: Figuring out (again) where the banks fit in
Some big questions in economics come and go, but one is there all the time: how are national income and output determined, and what does the answer mean for unemployment and inflation? Economists flopped this exam question when it was put to them in the Great Recession of 2008. In the coming decade, they will be trying to do better.
Keynes is supposed to have supplied a good reply. Unfortunately, in the last 20 years, central banks have instead preferred “New Keynesianism,” a three-equation model which has been widely described as the workhorse of modern macroeconomic analysis.
But in 2008, it was useless. Not one of the equations referred to the banking system, or the quantities of bank credit and money, even though it is obvious that banks were important in the Great Recession. One of the equations (the so-called “Taylor rule”) prescribed heavily negative interest rates to deal with the slump. This would have been fine, except that interest rates cannot go much beneath zero. New Keynesianism ought long ago to have been sent to the knacker’s yard.
The main intellectual challenge for economics now, just as it was when Keynes was writing, is to identify how the banking system—with its alleged masters of the universe, and its undoubted manias, delinquencies and pathologies—interacts with the rest of the liberal capitalist democracies of today.
Tim Congdon, Chairman of the Institute of International Monetary Research