Highlights

Stumbling and Mumbling

Author: chris dillow   |   Latest post: Tue, 16 Oct 2018, 01:25 PM

 

McVey's Rumsfeld assumption

Author: chris dillow   |  Publish date: Tue, 16 Oct 2018, 01:25 PM   |  >> Read article in Blog website


When she was told yesterday that some Universal Credit victims were being driven into prostitution, Esther McVey replied:

Tell these ladies that now we've got record job vacancies - 830,000 and perhaps there are other jobs on offer.

This, I suspect, is an example of a longstanding and widespread error on the right.

I don't mean merely the failure to see that what's possible for one person cannot be possible for all. Even if every unemployed person were to magically fill one of the 832,000 recorded job vacancies, there'd still be 531,000 unemployed and a further 1.9 million people out of the labour force who'd like to work. Esthermcvey

Instead, she's committing what we might call the Rumsfeld assumption. He famously said "people are fungible. You can have them here or there." But this is not true in the labour market. Just because there are lots of vacancies, it does not follow that the unemployed can fill them. If vacancies are for bricklayers or software writers, an unskilled woman will be unable to fill them. People are not fungible. They cannot move to any job that's available. Each unemployed person is slightly different from the next, and each vacancy slightly different. What matters is that the two match up. Rightists under-estimate this problem. Take three examples of this:

- In 1981, Norman Tebbit told the unemployed to get on their bikes and look for work. He under-estimated the fact that it was difficult for jobless manufacturing workers to adapt themselves to the (few) new jobs that were available.

- During the miners strike, Patrick Minford supported pit closures on the grounds that the unemployed miners would find work elsewhere. Generally, they didn't.

- Some Brexiters today claim that any jobs lost in exporting to the EU will be compensated for by new jobs in - I dunno - exporting to Discworld or Narnia.

In all these cases, the right over-estimate fungibility. They under-estimate the amount of sand there is in the wheels of the market mechanism, and so under-estimate market frictions. Ms McVey is following a long tradition. Here, for example, is John van Reenen and colleagues on Economists for Free Trade:

Minford uses a 1970s-style trade model in which all firms in an industry everywhere in the world produce the same goods and competition is perfect. There is no product differentiation - a German-made car is identical to a Chinese-made car. Importantly, trade does not follow the gravity equation - everyone simply buys from the lowest cost producer.

In other, words, Minford's world is one in which everything and everyone is fungible. But they are not. Just as some leftists have a unrealistically utopian vision of how socialism works, so some rightists are too utopian about markets and thus about our ability to adapt to disturbances such as to aggregate demand or trading rules. It is no coincidence that support for Brexit and faith in free markets are so correlated: both derive from the same dubious assumption.

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Brexit, Marxists & the state

Author: chris dillow   |  Publish date: Sun, 14 Oct 2018, 12:33 PM   |  >> Read article in Blog website


Was Marx wrong? This is the question posed by Brexit.

I'm prompted to ask by this from the government's advice to business on what to do about a no-deal Brexit:

UK companies and limited liability partnerships that have their central administration or principal place of business in an EU member state may wish to consider whether they need to restructure to satisfy the requirements for incorporation in that EU member state.

Faisal Islam says this is the "first time in history a UK Govt [has] effectively suggested shifting HQs out of UK." We've gone from Johnson's "fuck business" to "fuck off business". Brexit threatens even worse than prolonged slower growth than we'd otherwise have.

This challenges Marx. He thought "the executive of the modern state is but a committee for managing the common affairs of the whole bourgeoisie."

Now, there's tons of evidence for this far beyond the state's role in protecting property: state education prepares workers for capitalist drudgery; the welfare state helps to stabilize demand whilst incentivizing people to enter the labour market; and under Thatcher and Blair, a big part of economic policy was aimed at attracting businesses and maintaining confidence.

But no more. Brexit is antagonistic to the interests of capitalists. How, then, can we maintain Marx's view that the state is a means of promoting the interests of capital?

One possibility is that the interests of capital do not consist merely in high and rising profits. They also require that capitalism be seen as sufficiently legitimate that it can persist without grievous unrest. Because egregious exploitation and inequality would undermine its legitimacy there is therefore a role for the state to impose some progressive taxation or labour regulation. Sometimes, capitalists must be saved from themselves; it is their collective interest that matters, not that of individual spivs.

I'm not sure, though, that this is relevant to Brexit. Granted, backtracking from Brexit might undermine the legitimacy of the state in the eyes of some. But it wouldn't delegitimate capitalism. And whilst it might provoke civil unrest, this probably wouldn't be so great as to cost capitalism more than would a hard Brexit. Queequeg_runs_from_Dana_Scully

This leaves us another possibility, described by Ralph Miliband - that the state has relative autonomy. To borrow a neat analogy (pdf) from another discipline, think of the relationship between capital and the state as being like that between a woman and her dog on an extendable lead. In the short-term, the dog can run a long way from his mistress and do all sort of damn fool things. But ultimately, it usually* gets dragged back into line. Chile in the early 70s, France in the early 80s and perhaps the Tsipras government in Greece more recently are examples of this.

Brexit could fit this pattern in one of two ways. One way would be for us to end up with a "Brexit in name only" - if economic chaos, or just warnings thereof, cause a backtracking from a hard Brexit. Whether this happens via a general election or "people's vote" is not important in this context.

But there's another way. With even a smooth Brexit likely to depress longer-term growth, it'll be more imperative than ever for governments to attract capital and maintain confidence**. In this way, capital's hold over the state will strengthen; if Brexiters weren't so stupid, I'd suspect this was their motive.

All this, however, leaves Marxists with a problem. If any policy whatsoever could be seen as examples of promoting accumulation, sustaining legitimacy or of relative autonomy, what might represent refutation of our theory of the state? Does this just become an unfalsifiable theory?

I don't think so. The theory predicts that where there is a choice between promoting human flourishing and the interests of capital, the state will eventually opt for the latter. This prediction can be refuted by events, though it rarely is - but this is another story.

* In my picture, the dog runs to its death. Some of you might think this undermines my metaphor, others that it strengthens it.

** Fiscal policy is not the issue here. MMTers are right to say the state can borrow as much as it wants, subject only to an inflation constraint. But this doesn't alter the fact that tax and industrial policy must sustain profits.

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Adam Smith's two economies

Author: chris dillow   |  Publish date: Thu, 11 Oct 2018, 02:00 PM   |  >> Read article in Blog website


Adam Smith thought there were two economies - meritocratic for the poor and powerless and anti-meritocratic for the powerful:

In the middling and inferior stations of life, the road to virtue and that to fortune, to such fortune, at least, as men in such stations can reasonably expect to acquire, are, happily in most cases, very nearly the same. In all the middling and inferior professions, real and solid professional abilities, joined to prudent, just, firm, and temperate conduct, can very seldom fail of success...The good old proverb, therefore, That honesty is the best policy, holds, in such situations, almost always perfectly true. (The Theory of Moral Sentiments, Part I, Sec 3, Ch 3)

But:

In the superior stations of life the case is unhappily not always the same. In the courts of princes, in the drawing-rooms of the great, where success and preferment depend, not upon the esteem of intelligent and well-informed equals, but upon the fanciful and foolish favour of ignorant, presumptuous, and proud superiors; flattery and falsehood too often prevail over merit and abilities. In such societies the abilities to please, are more regarded than the abilities to serve.

This fits the theory of a friend of mine. He says that further up the hierarchy one goes, the longer it takes to identify merit, and so the more chance shysters and bluffers have of thriving. You can spot immediately whether someone is capable of sweeping a factory floor, but it takes longer to discover whether they can manage the factory.

Which raises the question: how extensive is the anti-meritocratic economy? Karen Bradley's recent admission to being clueless about the province's politics before she became Northern Ireland secretary was merely the latest and most egregious reminder that in politics merit and abilities are not always decisive to preferment. Kim-Kardashian-Elizabeth-Sullivan-Photoshoot-5

And since Smith's time, we've seen the rise of celebrity culture - a whole sub-economy of media and entertainment where abilities to please (and dumb luck) produce Adler superstars (pdf), people whose success rests upon simply being talked about. Boris Johnson and Kim Kardashian have much in common in this respect - the difference being that one has a massive arse and the other is a massive arse.

It's easy to believe the same is true near the top of corporate hierarchies. Top managers often prefer to hire men in their own image - partly because they are more likely to trust them. This gives (pdf) us the Peter principle - that people are promoted to their level of incompetence - and the Dilbert principle, that duffers are more likely to be promoted. And their charm and deceitfulness mean that psychopaths are over-represented in top jobs.

All this is compatible with evidence that there is a "long tail (pdf) of extremely badly managed firms" with low productivity (pdf): this is what we'd expect if managers are promoted on factors other than ability. (And no, the wheels of competition don't grind so finely as to swiftly eliminate such laggards.)

In this context, a new paper (pdf) by Andrew Oswald and colleagues challenges my priors. They estimate that only around one-eighth of workers in Europe has a bad boss - fewer than one would expect if ; flattery and falsehood too often prevail over merit.

Perhaps, though, the question here is not merely about numbers. Instead (as is often the case) it is about mechanisms. Are the mechanisms that select for merit and abilities rather than flattery and falsehood really as extensive as they should be? And if not, how can we change this - assuming of course that we want to?

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Our insular culture

Author: chris dillow   |  Publish date: Tue, 9 Oct 2018, 01:45 PM   |  >> Read article in Blog website


There are only three economies in the world - the UK, US and Venezuela.

Or at least, this is what you'd think listening to the recent reaction to Labour's plans for nationalizing utilities and more worker say in corporate governance. Rather than see these for what they are - steps towards European-style social democracy - many on the right greeted them with shrieks of "Venezuela!!".

This reflects a longstanding and paradoxical defect in British (English?) political discourse: that although Brexit dominates our politics our knowledge of European polities is near-zero, and certainly not strong enough to form obvious reference points. It's not just the right that is guilty here. So are leftists. Whenever free marketeers propose reforming the NHS, they immediately invoke images of dystopian American healthcare rather than, say, the Swiss or German systems.

Our ignorance of Europe takes countless very sensible questions off the agenda such as: why is the Finnish education system so good? What can Norway's experience tell us about the case for a sovereign wealth fund? Why do the Netherlands and Germany have such low youth unemployment? How might we improve vocational education or support SMEs? How best can we design a welfare state that minimizes poverty without greatly diminishing work incentives? And so on.

One of the basic principles of good management is that one should learn from best practice. The absence of Europe from UK politics means we don't do this. Our political culture imports the worst from corporate management - such as leadershipitis and PR bullshit - but not the best. Dad's_Army_-_Opening_Titles

This lack of Europe helps entrench another baleful aspect of our political culture, which we saw during the party conference season - an over-valuation of the merits of speeches. This, of course, reflects our backward-looking and anti-historical mythologizing of Churchill as merely a bellicose rhetorician. In this mythology World War II - which is one of the very few referents available to our impoverished political discourse - was won by fine words rather than by collective organization. The gruntwork of good administration and consensus-building are thus under-rated. Our ignorance of Europe means there's no counterweight to this.

It's not hard to find the cause here. We are a monoglot nation. My experience of learning French and German consisted largely of being shouted at by lunatics. Whilst good preparation for the world of work, this did not instil me with Europhilia*. And I'm not as atypical as I should be. Even Gordon Brown, one of our most educated politicians of recent times, looked to the US rather than Europe for his influences.

Herein lies another paradox. Whilst the left considers itself internationalist and centrists flatter themselves to be modern sophisticates, it is the nationalist right which in practice does more to resist this. Links between Farage, Le Pen, Orban, Trump and Putin are perhaps stronger than those between their civilized counterparts.

The media, of course, reinforce all this. The issue here is not merely that lies about the EU have suited its agenda for decades. It's that reasonably good government is not news. There is therefore silence about policy successes on the continent. In this way, as in others, the news creates a bias against understanding.

I suspect that the net effect of the de facto absence of Europe from political debate is to support neoliberalism by creating the impression that the only alternative to it is economic disaster such as Venezuela is enduring. This, though, is a secondary point. What is more certain is that contributes significantly to bad government and silly political debate.

* It was only quite late in life that I learned that the point of learning French was to better understand the songs of Jacques Brel.

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The state & profits

Author: chris dillow   |  Publish date: Sat, 6 Oct 2018, 01:03 PM   |  >> Read article in Blog website


Has British capitalism become more dependent upon the state in recent years? I ask because of a curious development in how profits are made.

First, let's remind ourselves of a basic fact - that UK capitalism has evolved in a very different way to the US recently. Whereas the share of profits in US GDP has risen markedly since the 1990s, the UK profit share has fallen since then. Yes, the share soared in the 70s and 80s - from what was an unsustainably low point in the mid-70s. But that rise ended 20 years ago. The profit share now isn't much above what it was in the 50s and 60s. Richard is right to say that labour's share of GDP has fallen since then, but this is due more to rising taxes on production and to rising rents eating into wages and profits, rather than to a higher profit share. Profshare

Although the profit share hasn't changed much except for the slump in the early 70s and subsequent recovery, the components of it have done so.

To see this, we need to manipulate the national accounts a little. GDP is equal to the sum of consumer spending (C), investment (I), government spending (G) and net exports (NX). It's also equal to wages (W), plus profits (P), plus taxes on production (T), plus other incomes such as rent and those of the self-employed (O). Rearranging these gives us four components of profits:

P = (C - W) + (I - O) + (G - T) + NX.

This equation is intuitive if you think of the circular flow of income. Profits are high (other things equal) if consumption is high relative to wages - that is, if workers return their wages to capitalists in the form of consumer spending. They will also be high if capital spending is high relative to other incomes: this is because one firm's investment is another's orders. They'll also be high if government spending is high and taxes low, and if net exports are high - that is, if foreign demand for UK goods and services is strong.

My chart plots these four components as a share of GDP since the ONS's quarterly data began in 1955: they are simply a rearrangement of the data in tables C1 and D of the quarterly national accounts. If we add the four lines together, we'd get my first chart.

And here's the strange thing. Except for net exports, which have been small and quite stable, these components have changed quite a lot. Profcomp

Take first the consumption-wage element. In the 50s and 60s this typically represented around one-third of the profit share. It fell in the mid-70s, largely because the savings ratio rose; in effect, workers no longer gave capitalists back so much of their wages in the form of consumer spending. This, along with the fall in net exports as a result of higher oil prices, was the main reason for the profit squeeze then.

Since the mid-70s, however, consumption minus wages has risen markedly, so it is now by far the biggest component of the profit share. In part, this reflects a fall in the savings ratio. One reason for this is that the fall in inflation after the mid-70s reduced uncertainty. Another is that credit liberalization in the early 80s allowed workers to spend more, relative to their wages, than they did before. Also, of course, non-workers spend money as well as workers. Increased pensioner incomes since the 70s - the near-elimination of pensioner poverty - has raised consumption relative to wages, as more recently did the introduction of tax credits.

That said, C - W has declined since the mid-90s because the employment rate has risen. Ceteris paribus, this tends to squeeze the profit share simply because capitalists now have to pay more of their consumers - although of course they get a share of a bigger pie. Even after this decline, however, C - W is much higher than it was in the 50s and 60s.

Turn now to our second element, G - T. This is government consumption plus subsidies minus taxes on production. This tends to be counter-cyclical, supporting profits in bad times such as the mid-70s and 2008-09 but giving less support in good. Even now, however - after years of austerity - it is much the same size as it was in the 60s. This is because government consumption, in current price terms, is a slightly bigger share of GDP which offsets higher taxes on production.

Now, here's the big thing. Look at I - O. It varied between 5% and 10% of GDP in the 60s, slumped in the 70s and has been around zero ever since except during the Lawson boom.

This has tended to squeeze profits partly because more revenues are going to landlords: Ricardo had a point when he predicted that rising rents would tend to squeeze profits. It's also because investment has fallen as a share of GDP: this hit 20% in the late 60s but has been 16-17% lately. This squeezes profits simply because one firm's capital spending is another's order book. As Kalecki said, capitalists get what they spend.

If we put these trends together, the conclusion is that capitalism is less self-sustaining that it used to be. Profits are more dependent upon state intervention - not just government consumption but also policies to ensure that consumption stays high relative to wages such as payments to pensioners and tax credits. Meanwhile, the private sector is doing less to support profits; investment is lower and rents higher.

Put this another way. We can imagine a healthy, vibrant capitalism in which investment is high and profits high as a result and so the system in not so dependent upon state help. And we have to imagine such a system because it is a long way from the one we actually have.

This is not to say that the state has become more interventionist despite the pretence that neoliberalism is a free market ideology. It's just that the nature of intervention has changed. During the golden age of capitalism, the implicit assurance that the state would ensure full employment and high demand encouraged firms to invest heavily.

Perhaps instead the point is that capitalism has almost always been dependent upon the state: as William Ashworth's new book describes, the industrial revolution was the result of an activist government. Free market capitalism is a myth now, and usually has been.

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What counterfactuals (don't) tell us

Author: chris dillow   |  Publish date: Wed, 3 Oct 2018, 01:59 PM   |  >> Read article in Blog website


Imagine if Labour had won the 2015 general election. What would the country look like now?

We'd probably have had less austerity and therefore higher incomes and perhaps higher interest rates. House prices might be a bit lower, but still unaffordable for many young people. The rich would probably be taxed a bit more and whilst there would have been no "hostile environment" policy there would be migration controls.

Much of this, though, is uncertain. What there would certainly be, though, is lots of moaning. The left would still be complaining about inequality, slow wage growth and under-funded public services, and the right about high taxes and the nanny state. And of course, there'd be complaints about the low-levels scandals and incompetences that are an inevitable part of even tolerably decent governments. Gordon Brown was massively criticized (often rightly) whilst he was Prime Minister even though in retrospect he looks like a political giant compared to who followed him. EdMDoDWk6DXkAYudiH

And there's one thing there wouldn't be - relief. Nobody would be saying today: "For all his faults, at least Miliband hasn't given us a chaotic Brexit; the lower incomes that result from a weaker pound; and harsh austerity." Nor would anybody be saying: "I'm alive today because Labour didn't extend Tory cuts." Centrists would not be celebrating Miliband for saving us from Brexit.

The point about counterfactuals is that nobody sees them. This trivially obvious fact has (at least) two implications.

One is that we don't praise governments sufficiently for avoiding really bad outcomes. Leftists, for example, don't give New Labour enough credit for simply not being a Tory government. We should judge governments not just by what they do, but also by what they don't. One of the great achievements of a Miliband government would have been the non-policy of not having a Brexit referendum: that, remember, was an attempt to exorcise the Tories' neuroses; it was not a priority for Labour. (Similarly, one of the great successes of the Wilson government of 1964-70 was that it kept us out of the Vietnam war).

The other is that governments are insufficiently criticized for policies that impoverish us relative to a plausible counterfactual. Simon estimates that fiscal austerity has cost £10,000 per household, compared to what we'd otherwise have. But nobody feels this as a deprivation in the way they would a £10,000 bill they could see. Equally, even if Remainers are right and Brexit does make us worse off than we'd otherwise be, few people will experience this as a direct loss. There'll be no Jim Bowen in 2030 inviting us to look at a more prosperous economy and telling us "here's what you could have won."

Perhaps, though, there's something else here. Our counterfactual mediocre-ish Miliband government would be copping lots of flak even though it would be vastly preferable to what we have. This tells us that we cannot judge the quality (or not) of a government by the amount of criticism it attracts, not least because so many hyper-ventilate about the smallest mis-step. Pundits are noise, not signal.

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Ideology for normal people

Author: chris dillow   |  Publish date: Tue, 2 Oct 2018, 02:05 PM   |  >> Read article in Blog website


Jeff Sparrow accuses the left of being smug elitists who dismiss ordinary people as being dopes and fools. I don't doubt that there is an element of superciliousness within the left. But there needn't be. We can believe that people are misled by ideology into supporting the right without believing that they are stupid slack-jawed yokels.

Let's start with behavioural finance. This is the idea that investors - including professional ones - fail to optimize because they are prone to many cognitive biases. This doesn't mean they are idiots: even doctors (pdf) make similar mistakes. It just means none of us are Godlike Bayesians who always make the right decisions. Instead, we are - as the title of Meir Statman's fine book says - just normal people. There's a close analogy between some of the biases we see in behavioural finance and some we see in politics. This is why I can shift easily from writing about behavioural finance in the day job to writing about ideology in this blog: the two have much in common. For example: Cletus_and_Children

- Anchoring. Kris-Stella Trump has shown that our perceptions of what is fair are anchored by actual distributions. This means that as inequality increased, so too did our perceptions of how much inequality is acceptable. But we also see anchoring in finance. Before the crisis, years of stability anchored bankers' ideas of how risky their assets were, with the result that they took on too much risk and subsequent losses came as a shock (pdf) to them.

- Prospect theory. When people have lost, they tend to gamble in an effort to break even. I suspect this helps explain support for Trump and Brexit; people who felt that the country had lost out to globalization and to the elites were willing to gamble on risky prospects. We see a similar thing in financial markets. People hold onto badly performing shares in the hope they'll come good. And they have traditionally paid too much for lottery-type stocks (pdf) such as Aim shares which offer the small chance of great returns.

- Under-reaction. People stick too strongly to their prior beliefs. In politics, this means too many people think the Tories are good custodians of the economy despite austerity, Brexit and Johnson's "fuck business" remark. In finance, it gives us (or contributes to) the momentum effect - the tendency for assets which have done well recently to continue doing so.

- Wishful thinking and the optimism bias. These cause people to over-estimate their future incomes and to believe that austerity won't affect them. It thus creates a bias against high taxes and welfare spending. Again, we see a similar thing in finance; investors over-estimate their ability to pick good stocks or funds.

These are not the egregious errors of idiots. Instead, they are - as Statman says - very often good shortcuts that sometimes lead us awry; we are often right to cleave to our priors, and a little wishful thinking is necessary to get us through the day. We are all prone to some of these mistakes sometimes. And if we commit them in finance where the incentives to think clearly are high, aren't we more likely to commit them in politics where the incentives are weaker, non-existent or even perverse?

Now, I know that some of you are sceptical about the explanatory power of behavioural finance. Sometimes I suspect it is less of a positive project aimed at explaining the world than a normative one - a way of warning us against some common mistakes. Nevertheless, I suspect it does have some explanatory power. Insofar as this is the case, isn't it also likely that the same mechanisms which cause poor investment decisions might also cause poor political ones? And both arise not necessarily from stupidity but from the fact that our cognitive resources are limited.

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When detail matters

Author: chris dillow   |  Publish date: Sun, 30 Sep 2018, 01:02 PM   |  >> Read article in Blog website


Chris Giles says that in predicting that a no-deal Brexit will cause house prices to fall 35%, Mark Carney's has fallen "into the trap of giving his audience precise numbers at a time they are neither knowable nor helpful." This poses the question: when is precision and detail useful, and when not?

In this case, Chris is right. A precise number gives the impression of knowledge which is in fact not available to us. I'd prefer that Carney's warning was expressed as:

We have mechanisms which point to house prices falling because of Brexit: lower income expectations, plus heightened uncertainty (plus momentum effects after these have kicked in). These probably outweigh the positive effects upon house prices: increased optimism among Brexiters; and slightly lower interest rates. Although we can't quantify how these mechanisms will play out, we can be moderately confident of the direction of change.

There's another context when detail is unimportant - when we put it before general principles. Take, for example, McDonnell's plan for increased worker ownership. The significant thing here - at this stage - is not the details, but the question: do the benefits of greater worker ownership outweigh the disbenefits of a slightly higher cost of capital caused by the dilution of owners' current stakes?*

This is especially the case because the detail - at this stage - is malleable. The £500pa cap on the amount of dividends workers can get, or the 10% ceiling on their stake, can both change in light of evidence.

In fact, there's another reason why the details of MCDonnell's plan aren't very important. It's that our uncertainty about the size and net direction of their behavioural effects surely swamps any quibble about those details. There is, as Thomas Meyer wrote, sometimes a trade-off between truth and precision in economics. Precise numbers can distract us from what's really important, such as the confidence intervals around those numbers, and the costs of being wrong. In the run-up to the financial crisis, banks had precise estimates of value at risk which proved to be useless. They and us would have been better served by less precision and more truth. To take another, example, media demands that parties' spending plans be "fully costed" ignore the fact that there's massive uncertainty about future government borrowing.

Keynes didn't actually say "it is better to be roughly right than precisely wrong", but he should have done.

This speaks to another context when precision is irrelevant - when it is mere noise. The FTSE 100 fell by precisely 35.24 points on Friday. For almost all practical purposes, however, this knowledge is useless. It tells us nothing worth knowing, and certainly nothing about what really matters for investors, which is where the market is heading. In fact, for the purposes of this question, almost all precise knowledge is useless - and in fact, worse than useless if relied upon for asset allocation.

So, when does detail matter? One is that it can be a guide to whether a policy is practical. McDonnell's plan, whatever other demerits it might have, clears this hurdle. Brexiters' plans for the Irish border, by contrast, don't; they amount to little more than "technology, yeah!"

Detail also matters, of course, when it cannot change - when we've signed contracts and treaties. It's reasonable to demand more detail of those proposing a trade deal with the EU than of those proposing a change in tax rates: a trade deal is a bastard to change, a tax rate less so.

It also matters as a way of telling us whether somebody has thought seriously about a problem or not. The lack of detailed proposals for Brexit, for example, is as Chris Grey says, a sign that Brexiters just haven't confronted basic realities.

Finally, of course, there is some truth in the old saw, "the devil is in the detail." I suspect, for example, that the appropriate amount of worker say in the running of any business depends upon the detail of how knowledge, and about what, they have relative to management. This will differ from firm to firm, and cannot be known to policy-makers. Hayek's great insight, of course, is that sometimes (often) important detail cannot be known by a single person.

Sometimes, then, detail matters and sometimes it doesn't. I fear, though, that the media doesn't sufficiently appreciate this. Precision makes better headlines: "Carney warns of 35% slump in house prices" is a better headline than "Carney thinks house prices will probably fall by an unknowable amount." And interviewers sometimes prefer cheap gotcha quizzing about unimportant detail than about points of principle (at least when they are interviewing John McDonnell rather than Brexiters).

There are two useful things we should bear in mind here.

One is number sense. Sometimes, what matters is not a precise number, but questions such as: how confident can we be about that? Where does that number come from? Is it a lot or a little? The other is to be on guard against the illusion of knowledge. Detail and precision sometimes give us mere overconfidence, not genuine useful knowledge. We should ask: why does this matter? When we do, we can see that precision is only sometimes helpful.

* The policy is about corporate governance, not about giving a short-term boost to workers' incomes - a point some have missed.

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The neoliberal constraint

Author: chris dillow   |  Publish date: Thu, 27 Sep 2018, 01:44 PM   |  >> Read article in Blog website


There's something that troubles me about Labour's otherwise admirable plan for greater worker ownership. It's that it could fall victim to neoliberal* performativity.

What I mean is that there are two different ways to think about the plan. We could see it as a gentle step towards co-determination of a sort that's common in Germany. Or we could instead see it as Sam Dumitriu does, as a "straightforward hike in taxes on profits" - perhaps even as a form of expropriation - which will raise the cost of capital and so reduce investment.

This is where performativity comes in. Words are not mere words. How you describe the scheme determines its effects. The boss who regards it as a mild reform is likely to try to make it work. The one who regards it as a threat to property rights and to his empire is more likely to up sticks. If Sam's view is widely shared in boardrooms, his warning that firms will disinvest will be self-fulfilling. Ukrow

Now, in mere hydraulic terms, Sam's warning seems overblown. One Big Fact tells us this. UK share prices have under-performed the rest of the world for ten years, suggesting that the UK's cost of equity capital has risen relative to that elsewhere. AFAIK, however, critics of McDonnell have been relaxed about this - and perhaps rightly so, as it's difficult to establish that this has deterred investment and innovation**.

Hydraulics, however, are not the point. What matters is animal spirits. A rise in the cost of capital because of direct policy action might have worse effects upon investment than one caused by stock market falls for other reasons - especially to the extent that a Corbyn government will increase uncertainty anyway.

What I'm trying to drive at here is that neoliberalism doesn't just describe the world, but shapes it. As Jesse Norman says, "markets are living institutions embedded in specific cultures". Our culture is a neoliberal one, which affects how markets operate. For example:

- Tax. If you regard higher tax as a price worth paying to live in a civilized society, you'll be content to pay (moderately) higher rates. If, on the other hand, you regard it as theft then you are more likely to take steps to avoid it, either by working less, or migrating or dodging it by legal or illegal means. The shape of the Laffer curve depends upon tax morale and ideology. Neoliberal beliefs cause the revenue-maximizing top tax rate to be lower than it would be with social-democratic beliefs.

- Regulation. If bosses feel constrained to act with a sense of propriety in accordance with public morality - as Adam Smith thought we were - then they are likely to abide with new regulations. If, on the other hand, they regard them as restraints on the right to manage, they'll seek to game them or avoid them.

- Politics. If you regard politics as just another marketplace in which the customer is king, you'll defer to public opinion and thus downgrade expertise and representative government.

These are all ways in which neoliberal beliefs can be self-fulfilling. But they can also be self-refuting. For example, in the early 00s mainstream economists thought that securitization was a good way of pooling risks and thus of increasing financial stability. This emboldened banks to gear up, thereby causing a crisis.

My point here is a disquieting one. It is the case that many neoliberal ideas are plain wrong; neoliberalism, for example, might well have retarded productivity growth. It is not, however, sufficient to point this out. Neoliberal ideology - whether right or wrong - can create its own reality. Insofar as this is the case, it is a constraint upon what social democratic governments can achieve.

* Yes, I know some of you hate this word. But I can't think of a better one in this context.

** Though of course, ascertaining cause and effect is damnably hard: is the All-share's under-performance a cause of lacklustre growth, or the result of expectations of it?

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A Crisis of Beliefs: a review

Author: chris dillow   |  Publish date: Wed, 26 Sep 2018, 11:18 AM   |  >> Read article in Blog website


Whilst I was away, there was a debate on Twitter about why so many Oxford PPEists become newspaper opinion writers. The question was ill-posed: in fact only a teeny fraction of PPE graduates enter that profession - much less than 1%.

The idea that PPEists become opinion-mongers is an example of the representativeness heuristic - our tendency to over-estimate a probability if something seems representative of a group. In this case, because bashing out half-cocked opinions quickly seems representative of PPEists, people over-estimate the probability of PPEists becoming opinion-writers. In doing so, they neglect base rate probabilities: there are thousands of us PPEists but only a few opinion-writers.

For years, doctors have made this same mistake. Back in 1982 David Eddy showed that they over-estimated (pdf) the chances of patients having a disease if they had tested positive for it: because a positive test is representative of the disease, they neglected the basal probability of the disease. In Bayesian terms, people mistake P(A|B) and P(B|A): we all do. Crisis9780691182506_0

The same mistake explains the financial crisis of 2008, according to a new book, A Crisis of Beliefs, by Nicola Gennaioli and Andrei Shleifer. They argue that the market stability of the 90s and early 00s caused investors to over-estimate the probability of stability continuing - stability being representative of a healthy financial system.

In other words, they say, investors have neither the naïve adaptive expectations attributed to them by early Keynesians, nor fully rational ones. Instead, they update their beliefs in light of new evidence (such as prolonged stability) but do so in a quasi-rational way, to use Richard Thaler's phrase.

This theory fits a Big Fact - that the crisis was not a bolt from the blue. In a neat narrative of the events, Gennaioli and Shleifer show that the crisis was bubbling up for months before Lehmans collapsed: US house prices began falling in 2006 and some sub-prime lenders and hedge funds holding mortgage-backed securities collapsed in 2007. Such events did not trouble equity investors much, however, because they took past stability to be representative of future stability and so thought that the risks posed by the housing market were manageable. It was only when Lehmans collapsed and was not bailed out that this belief changed. And - in retrospect - investors over-reacted to that collapse because of the same representativeness heuristic: a banking crisis is representative of a dysfunctional economy, which led to shares falling too far.

Personally, I like this explanation, but with four caveats.

One is that it is not a full explanation of the crisis. Gennaioli and Shleifer do not ask why demand for "safe" assets was so high in the mid-00s. The deeper structural failings of capitalism that created that demand are outside the purview of their book.

Secondly, they fit this theory to only the 2007-08 crisis without applying it to others. This invites the old criticism that economists see something fail in practice and wonder if it can fail in theory.

I suspect, however, that it does have wider applicability. It might fit the tech bubble: sharply rising share prices are representative of great future businesses, thereby leading people to over-estimate the likelihood of companies becoming the latter. It might also be consistent with economists' longstanding failure to foresee recessions: growth is representative of normal stable economies, which leads us to under-estimate the chance of downturns.

Thirdly, they pay insufficient attention to the question: why doesn't the smart money correct this inferential error? The answer, in fact, lies in one of Shleifer's earlier papers - that there are tight limits on how far one can short-sell; if you're right at the wrong time, margin calls can wipe you out. There's a reason why John Paulson and Michael Burry were rarities in profiting from the slump in mortgage securities.

Finally, I fear they underplay mechanisms which reinforce inferential errors. For me, one of the most revealing statements of the crisis was that of Chuck Prince, then head of Citigroup, in July 2007:

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing.

This speaks to institutional and psychological pressures. The cautious manager who avoided sub-prime mortgages or shorted them under-performed his peers in the mid-00s and so faced calls from investors to change strategy; that scene in the Big Short where big investors demand their money back because being early is the same as being wrong rings true. And even without such demands, it's hard to disagree with the herd; as a great philosopher said, you must be strong if you're to go it alone. Again, though, Shleifer's own work speaks to this: his paper Chasing Noise describes the herding mechanism well.

You might think all this is minor stuff. It's not. Although the representative heuristic seems like a small deviation from rationality, it has a devastating effect. Gennaioli and Shleifer say:

We expect new financial products to load up precisely on the risks investors do not fully appreciate. Under rational expectations, financial innovation would improve risk-sharing and welfare. With neglected risk, in contrast, it creates inefficient risk-sharing and the possibility of crises. (p87)

In this sense, the psychological question of how expectations are formed raises a much more general question about the stability of the financial system. It is, therefore, a deeply political question.

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