All 11 entries tagged Economics

The Essence of Keynes and the Value of Macroeconomics

Writing about web page http://www.guardian.co.uk/books/2009/aug/30/keynes-return-master-robert-skidelsky

Reviewing Keynes: The Return of the Master, by Robert Skidelsky (Allen Lane), in The Observer on August 30, 2009, Paul Krugman remarked that Keynes himself at one time considered the core of his theory to be the rejection of Say's Law (that income is always spent);

Say's Law [Krugman writes] isn't true, because in a monetary economy people can try to accumulate cash rather than real goods. And when everyone is trying to accumulate cash at the same time, which is what happened worldwide after the collapse of Lehman Brothers, the result is an end to demand, which produces a severe recession.

At another time, however, Keynes suggested that the core lay in

uncertainty that cannot be reduced to statistical probabilities, what the former US defence secretary Donald Rumsfeld called "unknown unknowns". This irreducible uncertainty [Keynes argued and Krugman writes] lies behind panics and bouts of exuberance and primarily accounts for the instability of market economies.

Krugman noted that Skidelsky himself has moved closer to the second view.

Observationally, these two views are excellent markers today for positive and negative judgements of the field of modern macroeconomics. Those that emphasize uncertainty as the fundamental problem are likely to excoriate professional economists for the false precision of their mathematical modelling, and their inability to foresee the crash of 2008.

In contrast, those that emphasize the broken relationship between supply and demand as the core insight of Keynes are likely to commend many of the same economists for their prompt reaction to the same financial crisis; they were as good as their word, speedily putting in place the massive fiscal and monetary interventions that have saved us from a repeat of the Great Depression.

In truth and logic, these insights complement each other. If Say's Law held, uncertainty would not matter. Depressions are possible because Say's Law does not hold, but it is unpredictable animal spirits that trigger them. Thus both insights are essential to Keynesian macroeconomics

That being the case, it appears that macroeconomic policy makers did not completely lose sight of what matters most. Macroeconomic theory -- well, that's another story.

Mark Harrison : 23 Sep 2009 20:14 |  Tags: Economics Keynes Recession |  Comments (1) |  Close comments |  Report a problem

Who are the Friends of the Poor? Or, With Friends Like These …

Writing about web page http://www.guardian.co.uk/commentisfree/2009/aug/24/revolution-1989-1979

Recently David Edgar (In the new revolution, progressives fight against, not with the poor, The Guardian, August 25) told a story in which one stage character, the “neoliberal urban middle class,” takes sides against another, “the economically egalitarian, socially traditionalist, rural poor.”

As his story unfolds, it turns out that a century ago the middle class was a friend of the rural poor, but became a victim of unintended consequences. The Russian revolution, Edgar writes,

grew out of an alliance between the progressive intelligentsia and the poor. That alliance was betrayed when Stalin turned on the intelligentsia in the Great Purge of the 1930s, as Mao did in the Cultural Revolution of the late 1960s.

In part because of this betrayal, Edgar narrates, the middle class then turned on its former friend the rural poor or became, at best, indifferent to its plight.

The latest chapter in Edgar's unfinished story continues this story in the world since the end of the Cold War. Progressive thinkers in many countries, we read, from the Middle East through the former Soviet bloc to the UK of "New Labour," have narrowed down their focus to rights and liberties that are real only for themselves -- property rights, freedom of expression and movement -- and have lost interest in affirmative action to raise up the victims of poverty and discrimination.

How will the story end? Time to turn the clock back, Edgar concludes:

Those of us who fervently believe in liberty, secularism, free speech, gay rights, civil liberties, enlightenment values and feminism, but also in social diversity, religious tolerance and economic equality, need to set about dismantling the barriers that people who believe in only some of those things want to erect.

At the heart of this story is a problem. My problem is not the ideals that Edgar promotes, which are laudable, but with what he thinks happened in history. What truly happened in the mid-twentieth century? What really broke the old, altruistic alliance of progressive thinkers with the poor? Where, in fact, do the poor stand today?

The unintended consequences of Edgar's story are right, but the history is “not even wrong.” The events that mattered most involved betrayal not of the middle class but of the poor. These events came years before Stalin's Great Terror or Mao's Cultural Revolution.

To achieve their goals, both Stalin and Mao imposed famine on the rural poor. Neither Stalin nor Mao particularly intended to do this; but it happened -- twice. In 1932 to 1934,  Stalin's policies of forced industrialization and food redistribution killed between five and eight million people -- in far larger numbers than he would ever kill the middle class. Mao repeated this achievement in the aftermath of the Great Leap Forward of 1956 to 1958 on a still larger scale: twenty million or more are thought to have died as a result. Both Stalin and Mao did this with the enthusiastic support of some (but not, of course, most) progressive thinkers, East and West.

For the progressively minded middle class, what happened in history should be far more disturbing than Edgar's fictional plot. The truth is that, in the peacetime years of the last century, educated intellectuals committed to the service of “pro-poor,” affirmative-action politicians helped to kill off as many of the rural poor as a global war.

With friends like these, who needs enemies? The rural poor might be forgiven for thinking twice before renewing such an alliance.

Mark Harrison : 17 Sep 2009 16:56 |  Tags: Economics Politics Stalin |  Comments (0) |  Close comments |  Report a problem

Government and the Fate of MG Rover

Writing about web page http://www.bis.gov.uk/mgrover-report

The demise of MG-Rover in 2005 has many lessons. Most of them, no doubt, are in the official report, just published. 

But the most important political lesson may well be this one.

In 2000, the government tried too hard to keep MG Rover in business. It did not try hard enough to do the right thing.

The right thing would have been to let MG Rover go to the wall.

If a business asset is good only for stripping, it is predictable that the best-looking promises to keep it in business will come from asset strippers.

If MG Rover had gone to the wall in 2000, nearly everyone would be better off today.

• The taxpayer would have saved the £16m cost of the Phoenix inquiry and report.
• BMW would have saved the "dowry" of loans and grants to the Phoenix Four totalling £475m.
• MG Rover's creditors would have saved nearly £1.3 billion of bad debts.
• The MG Rover workers and their community would have saved five years of false hopes and delayed recognition of their true situation.

If the government had done the right thing in 2000, in fact, everyone would be better off today -- except the Phoenix Four.

Mark Harrison : 13 Sep 2009 19:48 |  Tags: Economics Politics |  Comments (0) |  Close comments |  Report a problem

Health Care: A Letter to Americans

Writing about web page http://www.telegraph.co.uk/news/worldnews/northamerica/usa/barackobama/6001372/Sarah-Palin-calls-Barack-Obamas-health-reform-plans-evil.html

Working on both sides of the mid-Atlantic discipline of economics, I find I spend a certain amount of time trying to interpret America to my British friends and colleagues. Less often, I have to do it the other way round. Now seems to be one of those times. Britain needs to explain itself to America.

It seems Britain has become an issue in America: specifically, our national health service. Recently Chuck Grassley, a Republican on the Senate finance committee, was quoted as saying:

I don't know for sure. But I've heard several senators say that Ted Kennedy with a brain tumour, being 77 years old as opposed to being 37 years old, if he were in England, would not be treated for his disease, because end of life – when you get to be 77, your life is considered less valuable under those systems.

Now, I have only limited claims to offer any insight worthy of note. Specifically, I'm not a health professional (or a health economist). But I am a person, so from time to time I get sick. As a parent I had to see my children, now grown up, from birth traumas through the usual illnesses and accidents of childhood and adolescence. Recently I turned 60, so I have started to encounter conditions that go with aging. Within the last 20 years I experienced the deaths of both parents, both of advanced age, one after a long illness and the other after a short one. Along with all that, I sometimes worry about nothing. For all these reasons, I have had plenty of personal experience of health care in the U.K. and consider myself qualified to talk about that. So:

Dear Americans, here are some personal answers to some of the questions that seem to be on your minds.

• Has the British national health service ever been a bad experience for you?

No. It has looked after me and those I love with unstinting professionalism.

• Has the British national health service ever denied you or your family treatment on grounds of cost?

No. We have occasionally been faced with delays for testing or treatment that were a little longer than was comfortable. It was more urgent in our eyes than in the eyes of the medics and managers.

• Do you worry about whether the state will pull the plug on you when you get older?

Absolutely not. I do worry that I will be kept alive beyond the point where I would prefer to slip away. That's another story, not for now.

• Is that just because you're a national treasure? Do the national health service bureaucrats just give out privileges to famous people?

Hmm, let's think about that. It sounds like the Stephen Hawking argument -- that Hawking survived our health service only because he was famous. I'm fairly sure my NHS doctor doesn't know I'm famous. That's suggested by the fact that last time I saw him he asked me what I did -- and then wrote it down. My wife and children like to think I might be famous but for some reason I'm keeping it from them. In fact, I'm keeping it under wraps so effectively that even I don't know I'm famous. Nope, I think I'll be treated exactly the same way as everyone else. Just like Stephen Hawking, in fact.

• Doesn't the NHS ration health care?

Sure. The truth is that health care is rationed everywhere. In a society without public provision, it tends to be rationed by price, or by the insurance premium. Those that can't afford it, don't get it. In the national health service, affordability is reckoned at various levels, national and local, but not in terms of the depth of my personal pocket.

• Is the NHS perfect, then?

No. It has many of the imperfections of government provision. For one thing, it can be squeezed by budgetary limits. As a result, bringing in expensive new hi-tech treatments can be at the cost of basic procedures or attributes such as cleanliness and diet in hospitals. Results are uneven: Britain is not very good at diagnosing and treating some cancers, for example. I could go on. The main thing is that, despite many imperfections, it basically sort of works. Specifically, it has been working for half a century without leading Britain to Nazi eugenics or a communist dictatorship.

You have to notice that David Cameron, who leads the most free-market mainstream political party that we have, is vociferous in defense of the national health service. Why? Because he knows it is very, very popular. It's popular because, despite the imperfections, it works.

• If you have to be in hospital, wouldn't you rather be in hospital in the United States?

Yes. It's a no-brainer -- American hospitals are the best in the world. At least, that would be my preference, conditional on having full insurance cover. But if you changed the question slightly, my answer would change. If the question was: "Unconditionally, which system would you prefer to live under?" then my answer would be the British one, because then I would not worry about needing treatment for conditions that were not covered by my insurer, or about exhausting the limits of my cover, or about possibly losing my job and my cover with it -- not only mine, but my family's cover too. Here, I am not afraid to be ill or injured. Of course, that's my personal choice; others might choose differently. But it is not an irrational choice.

• How do you square acceptance of tax-financed health care with free market economics?

The market economy can solve most problems, but not this one. There are three reasons. First, according to market principles, the consumer is sovereign. In the market for medical services, most of us face a huge difficulty in trying to enforce this idea: the doctor knows best! We are too ignorant, and too emotionally involved, to be the best experts in our own care. That's why it makes sense for a powerful intermediary to buy medical services for us. That intermediary can be either the government or a private insurer. This leads to the second reason: private insurers like to cherry-pick their risks. Poor people have consistently worse health outcomes, and so make poor risks. When the only intermediary is private insurers, they will inevitably tend to price poor people out of the market. Only a government scheme can make sure that poor people are included. The third reason is that poor people should be included. This is on several grounds, starting with social justice, including justice for their children, who are not to blame for their parents' life choices, and because otherwise poverty will spread untreated diseases through the community.

Within our national health service I am in favour of the unevennesses that give us individual choices. It's a good thing if all doctors, hospitals, therapies, and procedures are not exactly the same. This lets us compare results and make choices among them. I'm also in favour of the internal markets that let doctors choose between consultants and facilities from which to purchase care for their patients.

In short, the NHS does violate free market principles, but with health care these principles are going to be violated anyway -- even in a free market. Health care raises issues of market power, information, and health spillovers that do not arise in most markets. It is an exception.

• Doesn't government health care create huge bureaucratic overheads?

Well, yes. Interestingly, however, the overheads of government-financed medicine may not be as large as the overheads of insurance-based health care. As far as I understand it, my country commits a much smaller proportion of its GNP to health outlays -- and gets considerable better average outcomes than the United States, measured by life expectancy and many kinds of morbidity. Of course, there are confounding factors that complicate our understanding of the causes. Government purchasers are not necessarily any better than private insurers at holding down underlying costs. But it is not hard to see that taking ability to pay (or insurance status) out of the equation cuts out a lot of bureaucracy.

• Still, wouldn't you prefer to pay a voluntary insurance premium over compulsory taxes?

I pay both. And I do so very willingly. My taxes go to the national health service, which ensures that I and my loved ones are fully covered both for emergency treatment, and for all other procedures that are available although not necessarily exactly when we want it. My insurance premium then lets me bypass many queues if I need to. Moreover, the two systems mesh smoothly, allowing me to switch back and forth between them -- as I did recently when my NHS doctor recommended some tests that could not be done instantly within the national health service. My insurer paid so that I could have them done privately, and I took the results back to my NHS doctor.

In other words, it's not a question of government versus private provision. You can have both working together -- and in fact, in the United States, you do have both. It's a question of the right balance. The balance we have in the U.K. right now may not be perfect, but it is not a bad balance.

• Don't you mind that your taxes also pay for the care of needy and feckless people that pay no taxes themselves?

No. In fact, I'm very happy that the lazy scumbags get health care too. This is partly on pragmatic grounds, so that they do not pass their diseases onto others, and so eventually to me. Another reason is moral: poor and needy people have children who themselves can be in need of medical care. And from the moral to the personal: the poor and needy of the future might turn out to be my grandchildren! Or even my children! (I didn't mean to say that, it just popped out.)

• Does the NHS explain your bad teeth?

No, I obtain my dental care privately under an insurance scheme. My bad teeth are connected not with socialized medicine, but with the fact that I spent my childhood in Britain in the 1950s.

In conclusion, dear Americans, you must make your own minds up. We Brits can understand perfectly well the importance of private versus public, free market versus government, and individual versus collective responsibility. These are big important things that all of us should and will debate freely.

What we don't get is the depth of anxiety with which some of you face the prospect of wider sharing of health care. British experience gives plenty of food for thought. We may not have got it exactly right. But the choices we have made are well within the parameters of a society that is free as well as modestly equitable.

Keep well, Mark

Mark Harrison : 14 Aug 2009 15:38 |  Tags: Economics Health Politics |  Comments (5) |  Close comments |  Report a problem

How Can We Get to See What's Coming Round the Corner?

Writing about web page http://www.wehc2009.org/programme.asp?find=world+in+2030

At a meeting I attended earlier this week, some of the world's best economic historians discussed how the world might look in 2030, based on their knowledge of the long-run trends at work over the last couple of centuries (or, in the case of China, the last couple of millennia). People talked about trends, models, and forecasts, using a lot of numbers and graphs. The picture was generally optimistic, in a moderate sort of way.

One speaker worried about the small number of big things that, although they happen only rarely, might completely derail our visions of the future: things like deadly pandemics, Great Depressions, and global wars. Anther speaker worried about the rise of nationalism, how far it might go, and whether it could then have unpredictable effects.

This made me think about people that haven't had the benefits of a training in economics -- most historians, for example, but of course not only them. It occurred to me that such people often think about the future in a completely diffferent way, a way that is much more intuitive than economists' trends and models. They think about the future by telling stories taken from the past. (This is not a completely original thought. I began to think about it after reading "The Political Economy of Hatred," by Ed Glaeser, in 2005 in The Quarterly Journal of Economics 120:1, and more recently Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, by George A. Akerlof and Robert J. Shiller, published by Princeton University Press in 2008).

How do people use stories from the past to think about the future? First, they think about the conditions obtaining in the world today. Then, they scan the past for stories that began with initial conditions somewhat like these. They ask: "What happened next?" Then, they let the story unfold. From the story, they work out what might be about to happen in our own future. In this way, they try to see what's coming round the corner but still hidden from direct view.

Here are two examples.

• Today, we are in the early stages of a Great Recession that was preceded by a financial crisis. That's somewhat like the world economy in around 1930 or 1931. What happened in the Great Depression was a global contraction followed by the breakup of world markets, the rise of nationalism, the attempt of Germany, Italy, and Japan to carve out new empires, and World War II. Is that what might come next?
• Russia today is a great power that began the transition from totalitarianism to democracy -- and got stuck half way. The Russian political elite feels encircled by an old enemy, NATO, in the West, and a new rival, China, rising rapidly in the East. With a shrinking population, Moscow may well feel that time is running out. That's somewhat like Germany in around 1912. Germany was stalled half way from Prussian absolutism to parliamentary democracy. Germany was a rising power, but with the sense of being encircled by old enemies, Britain and France, in the West, and new rivals, Russia and Japan, that were rising even faster in the East. What happened next in that case was that the German political elite took an immense gamble. They launched World War I, not because they were confident of winning, but because they feared that time was running out. They feared the consequences of doing nothing -- the certain continuation (as they saw it) of peaceful decline -- more than the combined risks of victory and defeat if they started a military adventure. Is that what might come next?

Story-telling like this has some remarkable features. First, it is indeed a way of thinking about the possibility of rare and unpredictable events. As such it is immensely powerful. Its intuitive appeal is much greater than models, charts, and numbers. It speaks the language of nations and politics: shared experiences, common destinies, collective rights and wrongs. It is easily voiced by leaders and heard by followers untrained in statistical thinking about trends and standard errors. As a result, while politicians may turn to economists for technical advice, they get historians to help write their speeches -- Arthur Schlesinger Jr (John F. Kennedy), Richard Pipes (Ronald Reagan), and Norman Stone (Margaret Thatcher).

Second, story-telling is deliberately selective. When we scan history for stories, we look by definition for sequences of events that have a beginning, a middle, and an end. In the middle, something happens that is out of the ordinary, dramatic, and unexpected. Invariably, we rule out all those past historical circumstances that also somewhat resembled the present day, but after which there were no surprises and nothing much happened.

Third, story-telling typically sounds an alarm. In history, dramatic events are rarely good news. The good news in history has generally been made up of the slow, steady progress of emancipation, literacy, and prosperity. Such good news is easily illustrated by statistics and trends, but does not make good stories. It is the bad news of crises and wars that makes good stories.

Fourth, exactly because story-telling is alarmist, an entirely legitimate purpose of stories may sometimes be to sound the alarm about the risks we face and so avert their realization. Putting it in its best light, we sound the alarm of another Great Depression so that governments will take the actions necessary to save us from having to relive the experience. We warn of the danger of a new war so that governments will change their policies to a peaceful track. One result is that it is generally very difficult if not impossible to test the efficacy of story tellng as a form of prediction.

Fifth, some stories can be self-fulfilling. There is a particular kind of collective story, for example, that communal identity politicians like to tell (Glaeser wrote about this in "The Political Economy of Hatred"). These are stories of past hate crimes allegedly committed by some other ethnic or religious group against their own group: Black against White, Germans against Jews, Jews against Palestinians, Protestants against Catholics, Sunni against Shia -- and, in all cases, vice versa. Such stories can be extrapolated into predictions of future hate crimes yet to be committed, and then into justifications for hateful and violent action to preempt the future crimes.

Related to all this is the problem that we control the initial conditions of the stories we select only very imperfectly. The world economy today is only somewhat like the world economy of 1930; in many ways it is quite different -- and the differences may well turn out to be crucial. In the same way, Russia today is only somewhat like Germany in 1912. And so on. Thus, the stories we tell have the capacity to be deeply misleading about the true underlying risks in the world today.

If the risk of war or depression illustrated in the story does not materialize, this could be because telling the story stimulated effective action to avert the risk, or because the risk, although real, happened not to materialize this time (i.e. we were lucky), or because the risk was nonexistent in the first place; we may have no idea which is the case. If the risk of community violence does materialize, we don't know whether the underlying story merely predicted it -- or actually precipitated it.

In summary, such stories are powerful. They have great potential to illuminate the risks we face, but this potential is also dangerous; it is a power to accentuate risks, as well as to illuminate them.

I draw two simple conclusions from this. One is that economists and economic historians interested in addressing the wider public should think carefully about the stories that can put our messages across. The other is that we should pay close attention to the stories that others narrate in public about what has happened in economic history: we should look out for these stories, identify them, test them carefully against the evidence that we have, and then report the results to the public ourselves.

Mark Harrison : 06 Aug 2009 08:09 |  Tags: Economics History Politics |  Comments (0) |  Close comments |  Report a problem

The Social Work Taskforce: Why Not Just Pay Them More?

Writing about web page http://publications.dcsf.gov.uk/eOrderingDownload/DCSF-00752-2009.pdf

The British government's Social Work Task Force was set up to review "frontline" social work practice and to recommend improvements and reforms of the social work profession. Its interim report, out today, is entitled Facing Up to the Task.

Everyone can see that social work in our country is in a mess. If social workers fall down on the job they are treated like murderers; if they try to do it properly they get treated like the Gestapo. If they spend all their time on the "front line" they have no time left to talk to each other and to other agencies; if they talk to each other the way the government requires, they spend all their time doing paperwork and have no time for their clients. In the words of the report (page 12):

Widespread staffing shortages mean that social work is struggling to hold its own as a durable, attractive public sector profession, compromising its ability to deliver consistent quality on the frontline. There is no robust, standing system for collecting information on local and national levels of vacancies, turnover and sickness, and for forecasting future supply and demand. Local authorities are finding it hard to identify effective methods for managing the workloads of frontline staff. Staff shortages and financial pressures are making these challenges harder still.

In other words, a big problem facing social work managers today is that demand exceeds supply. That sounded to me like an economic problem. As an economist, without a background in social work, I thought about the Economics 101 solution: if demand exceeds supply the price should rise. Maybe social work would become more manageable if we paid our social workers more?

Sounds simple -- maybe too simple. How would it work? Well, in several mutually reinforcing ways:

• With higher salaries, more people with better qualifications would be attracted into training for the profession. (In today's Guardian, David Brindle quotes Sue Berelowitz, deputy children's commissioner for England, as saying some universities accept students on social work courses with E grades at A-level; some courses have pass rates for essays and exams of just 30%.)
• There would be fewer unfilled vacancies.
• A larger number of better qualified and more competent social workers would share out the work, so workloads would become more manageable.
• Properly managed, with higher salaries and lower workloads, even existing social workers ought to become more effective.

Given higher salaries, it is true, social service departments would probably have to reduce their social work staff complements. But this would be a price worth paying. With fewer posts unfilled, the number of social workers actually in post ought to increase. Departments would be spared the expense of frequent resort to expensive agency workers and consultants to make up for staffing shortfalls. And at least some social work catastrophes would be avoided, sparing everyone those other sorts of costs that then arise: deaths and injuries, investigations and trials, commissions of inquiry, imprisonments and sackings.

Given higher salaries, why would the existing social workers perform better? There are two reasons. First, the existing workers would have more, better people around them with whom to share the work. The other reason is that, the higher your salary, the greater is the cost of losing your job. Assume that bad social workers eventually lose their jobs. If so, then a higher salary would increase the cost of being a bad social worker, and so make existing social workers work harder to avoid being seen as bad. Of course, this depends on good performance management being in place so that bad social workers are actually let go.

All this is first-year economics. I wondered what the Social Work Task Force would make of the first-year answer. I note that the report emphasised the need to achieve "a much more sophisticated understanding of supply and demand." I looked for what this might involve. I found two things (both on page 18):

First, numbers of workers supplied and demanded:

A better future for social work depends on an appropriate supply of suitably qualified applicants into stable teams with the right mix of experience. The supply, recruitment and retention of social workers is therefore a central issue for reform. As a prerequisite for improvement, there need to be robust and durable arrangements for understanding and forecasting supply and demand across training and the job market.

I think what this means is that, in the view of the task force, one of the main instruments for bringing supply and demand into balance in the long term is forecasting demand and then increasing training places to match. The reference to retention, however, suggests an important role for pay, the factor that an economist would see as bringing supply and demand into balance. This brings us to the second thing I found (which actually came before the first one):

Social worker pay has also been raised in a number of different ways with the Task Force.

• Levels of pay are felt by some to be too low and not reflective of the importance of what social workers do and the pressures they currently work under. However, others have argued that levels of pay in themselves are not necessarily a decisive issue but assume importance because of wider problems with status, recognition and investment in training, support and the working environment.

• Pay differences within local authority teams between permanent staff and agency staff who may not be handling the same complexity of cases) are a source of some frustration and disillusionment.

• Shifts and variations in pay between local authorities are causing some dissatisfaction and may be contributing to movement and turnover in the workforce, with authorities competing to attract staff and address shortfalls through localised improvements in pay and conditions. This has led some to suggest that the profession needs a single national framework for pay and other conditions of employment in the statutory sector

Now, I understand very well that pay is not everything. If it were, I wouldn't be an academic. People come to many jobs, especially those involving education, health, and social care, because they are drawn to the work itself rather than the pay packet. In fact, people who care only about money would make bad academics and probably bad social workers too. Because of this, not offering very high pay can be a way of screening out people that care only about money (at this point we've moved from first-year economics to the second year).

However, it does not look to me as if the main problem in British social work today is that the profession is being invaded by money grubbers. On the contrary, there is an equal risk from offering relatively low pay: it can be felt as society's way of saying that the job is unimportant and a professional motivation is rubbish.

Because of this, for the sake of their motivation, it is important to pay people in proportion to their responsibilities -- and frontline social work is a very responsible job. If social workers are to match up to their responsibilities, commitment alone is not enough. The profession also needs to attract people that, in addition to being committed, are organized, fair-minded, team-oriented, competent, knowledgeable, and decisive, qualities that are valued highly -- and often highly rewarded -- in business. All this suggests that raising salaries could be part of the solution.

Raising salaries would seem to be a much more promising line of advance for the profession than the failed route of responding to crisis through frequent and costly reorganizations, reforms, and commissions of inquiry and task forces.

To give an example, every time there is a disaster, we are told that social workers failed to talk to each other and to other agencies. But competent, organized, knowledgeable, motivated social workers who are not crushed by overwork will talk to each other and to doctors and teachers without being told to do so. It is necessary to try to force social workers to do these things and to create artificial channels for them to do so, only because social workers are underpaid, underskilled, and overloaded.

To return to the report, if local authorities are being forced to raise salaries in order to compete for scarce social workers, isn't that a good thing? To judge from the tone of the task force report, "authorities competing to attract staff and address shortfalls through localised improvements" is being presented as a negative; "a single national framework for pay and other conditions" is put forward as the alternative to employer competition. When employer competition is pushing up pay, it looks like there are those that would prefer to hold it down.

A final thought on good and bad uses of money. One of the task force's headline recommendations is "The creation of a national college for social work" (page 40):

We are therefore exploring the case for a new organisation to support social work, which can play a role similar to that of the Royal Colleges that support the medical and allied professions. This might take the form of a national college for social work in England. ... In particular, the Task Force is interested in the potential for the national college to have a key role in driving learning and best practice in social work and provide a strong voice which speaks to the media about the profession. We are also considering the roles it might play bringing coherence to the professional and occupational standards which underpin different aspects of social work training and practice, and in relation to regulation of professional practice, training and education.

This Royal College of Social Work (say) would be in addition to the bodies that already exist: the General Social Care Council (GSCC), the relevant sector skills councils, the Social Care Institute for Excellence (SCIE), and the British Association of Social Workers (BASW).)

How much would this cost? In 2007/08 the Royal College of Nursing had 400,000 members and an annual budget of around £80 million, so around £200 per head of the profession it serves. In the same year the GSCC spent about £42m and the SCIE another £8m, so £50m for these two bodies to cover around 100,000 registered social workers and social work students. In other words, social workers were already paying around £500 per head for their own statutory regulation. (I'm not sure why it already costs so much more to regulate and support social workers than nurses.)

My question: wouldn't we all be better off if, instead of creating yet another expensive statutory professional body, we abolished them all and used the money saved to pay social workers more? Maybe there's a lesson in Economics 101 after all.

Mark Harrison : 29 Jul 2009 16:08 |  Tags: Economics Politics Social-Work |  Comments (3) |  Close comments |  Report a problem

Rationalising the Macroeconomy

Writing about web page http://www.ft.com/cms/s/0/478de136-762b-11de-9e59-00144feabdc0.html

In The Financial Times on July 21, Paul de Grauwe published the best comment I have read so far about the crisis in macroeconomic policy. If your time is scarce, don't read on; click the link and read him.

De Grauwe makes a fundamental argument, which I will summarize in four steps.

• Today, macroeconomists are distributed along a spectrum from "Keynesian" at one end and "Classical" at the other. They tend to clump at the extremes so there are many passionate Keynesians and passionate Classicals, as well as less passionate scholars in between.
• The Classical macroeconomists expect the macroeconomy to bounce back quickly from a major disturbance (for example, a credit crunch) on its own accord; government intervention is more likely to hinder than help. The Keynesians believe the opposite.
• For practical purposes, both schools model the behaviour of the people in the macroeconomy as follows: their behaviour is based on expectations of the future that are guided by the model, whether Keynesian or Classical. Classical macroeconomists assume that people's behaviour is based on the expectation that the outcome of the Classical model will be fulfilled, and Keynesian macroeconomists similarly.
• In both models, these expectations are self-fulfilling.

De Grauwe's punch line:

So what? Does it matter that economists disagree so much? It does. Take the issue of government deficits. If you want to forecast the long-term interest rate, it matters a great deal which of the two camps you believe. If you believe the first [Classical] one, you will fear future inflation and you will sell long-term government bonds. As a result, bond prices will drop and rates will rise. You will have made a reality of the fears of the first camp. But if you believe the story told by the second [Keynesian] camp, you will happily buy long-term government bonds, allowing the government to spend without a surge in rates, thereby contributing to a recovery that the second camp predicts will follow from high budget deficits.

In short, in a Keynesian model, the agents are assumed to expect that a credit crunch will have lasting adverse consequences. As a result they will rein in consumption (because households expect lower incomes) and investent (because firms expect depressed markets). The economy will stay depressed until government action flips the economy back to normal. But in a Classical model, the agents are assumed to expect that a credit crunch will soon be overcome, provided markets are allowed to work normally. Do nothing, and any damage to confidence will soon be restored. Unnecessary government action, however, by enlarging public spending and debt, will depress long term expectations and so inhibit the restoration of confidence.

This point is not new. I'm not sure who made it originally. It has been around a long time. I checked my notes from 1998/99, the first year I lectured to first year undergraduates at Warwick on this particular topic. I found the following passage:

We’re trying to explain a state of the world in which at least some unemployment is involuntary, money isn’t instantly neutralised by price change, and business cycles last anywhere between 5 and 9 years. The fundamental problem of the RE [rational expectations] approach is that it proves this state of the world can’t exist. Underlying this are some basic conceptual faultlines.  Learning from experience may be more difficult than RE theory assumes. Large experiments are rarely if ever repeated under controlled conditions (e.g. joining, then leaving the ERM). Large shocks (e.g. oil shocks, monetary shocks) make it hard to discern the underlying things which remain the same.  What is the true model of the macroeconomy? RE theorists tend to assume that most people adhere to a Classical philosophy. But since economists have such difficulty decided how best to model the economy, it’s not clear why rational non-economists should be different. Policy demonstrably does affect the real economy, so why should rational people believe it won’t?  This is particularly important since the outcomes of actions based on RE tend to force the world to conform to the model, not the other way round. What is created here is a "guessing the winner" problem: what’s important in forming rational expectations is not "how does the economy work?"; nor even "how does the economy work in my opinion?"; but "how does the economy work in most people’s opinion", bearing in mind that in forming their opinions they are all asking themselves the same question.

I claim absolutely no credit for this; I was not saying anything original. I got the argument from somewhere or someone else. My point is that the basic paradox in rational expectations has been understood for a long time, but the horrendous policy implications are perhaps only now fully apparent.

How bad does that make economists? Ten years ago I told my students that the idea of rational expectations, although not wrong, contained a paradox. I had no idea how to resolve it, however. One route the profession has taken has been to consider that, just as economists learn, so do non-economists. As a result, macroeconomic models have been developed that incorporate heterogeneous expectations -- when different people in the macroeconomy start out with different models of how the economy works and so different forecasts of the future -- and model how they might then learn from experience. A recent review by George W. Evans and Seppo Honkapohja is here.

This takes me well outside my comfort zone. I thought about it, however, when a friend forwarded some lines from an internet discussion including the suggestion:

Until the "science" of economics detaches itself from econometrics and unilateral modelling and realises that humans are "rationalising beings", not "rational beings", then the predictions and opinions stemming from its adherents should be treated with caution.

In the context I took the gap between "rationality" and "rationality" to reflect some falling short of cognition or computation. It wasn't that I disagreed; the suggestion seemed almost trivially true (apart from the reference to econometrics, which seemed silly). What it made me think is this: If humans are "rationalising beings," then so too, being human, are economists. All economic models have cognitive and computational limits. They model reality; they don't and can't reproduce it. 

In the often misquoted words of George Box and Norman Draper (from Empirical Model-Building and Response Surfaces, New York: John Wiley 1987, p. 63):

All models are wrong; the question is how wrong do they have to be to not be useful.

Mark Harrison : 27 Jul 2009 09:15 |  Tags: Economics Keynes Politics Recession |  Comments (3) |  Close comments |  Report a problem

What Should Every Econ Grad Student Read?

We sat round the table discussing what is missing from the reading lists of today's graduate students in economics. Today's syllabuses concentrate heavily on stocking up their mathematical and econometric toolkit. I don't have a problem with that. On the contrary, I regret the technical deficiencies in my own background, and I regret them more as it becomes less likely that I'll ever make them good.

Still, we worried: do today's syllabuses neglect a broader understanding of how institutions have evolved and of what history shows? What should every economics graduate student read?

There has been a lot of comment recently on how to educate today's kids in animal spirits, neuroeconomics, and behavioral stuff. But that was not at the centre of our concern, important though it is (I wrote about it recently here). This is a correction that is already under way. When Thomas Sargent says that rational expectations is "oversimplified," it won't take long to trickle down into advanced macro.

What bothered us is deeper issues: are today's graduate students learning, discussing, and debating how successful market economies have evolved, and how and why markets work, what stops them working, and how best to let them work?

One suggestion was that the graduate students should all read The Wealth of Nations by Adam Smith (1776). The only Nobel laureate at the table (for this was Stanford) dismissed the idea with a wave of the hand. "Too eighteenth century," he said.

Overawed, I kept my mouth shut. Here is what I thought afterwards.

My first recommendation is an article called "The Use of Knowledge in Society" by Friedrich von Hayek (1945). Here, Hayek explained how markets economize on information. In a market economy, supply and demand allocate resources without outsiders or superiors needing to possess complete information about individual preferences or firms' capabilities. Bureaucracies, in contrast, need to know everything about you, me, and everyone else, before they can make decisions. Where market economies thrive on information, bureaucracies choke on it -- something that I see daily, sitting in the Hoover Archive among the milliions of documents bequeathed to history by the Soviet command economy.

Having read that, a natural question, particularly in our present-day context, is: what should be done when markets nonetheless fail? Here I turn to Oliver Williamson (1985), who proposed the idea of the "impossibility" of selective intervention. Most people think we should aim to combine the best of market forces and political action (I do too). Let the market economy do its wonders where it can; where it can't, let the government intervene and fix things. Williamson points out that in principle this cannot work out. The reason is that there is intrinsic uncertainty about where political action can allocate resources better than markets. If you give politicians the power to intervene selectively, it is certain that some of their interventions will make things worse. (And they do! Look around you!) As a result, no government, democratic or otherwise, can commit to intervene only when the result will improve social welfare.

Despite this, governments do intervene. When they do, do they improve things on balance? An essential handle on this question is provided by an article on "The New Comparative Economics" by Djankov et al. (2003). I do not know whether this article has truly founded a "new comparative economics" but it does conceptualize and model a fundamental idea. This is that every society faces its own trade-off between losses from political action and inaction. The absolute losses can be large or small, depending on each society's institutional arrangements, but every society has its own optimum. There is no guarantee that an optimum will be reached, however. Learning where we are in relation to our own optimum is similar to understanding whether we are suffering from too much or too little intervention.

Finally, although selective intervention is impossible, government have historically intervened and have often required the advice of economists to do so wisely. And they will continue to do so. Therefore, graduate economists need to understand how their advice can affect both economic policy and the economic lives of millions. In particular, every graduate student should know more about the Great Depression. No one has written a better account than Peter Temin (2000), and the story he wrote ten years ago has vivid, extraordinary relevance for the present day. I hope he is proud of it; he should be.

Unless you have a better idea ...

References

• Djankov, Simeon, Edward Glaeser, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer. 2003. The New Comparative Economics. Journal of Comparative Economics 31:4, pp. 595-619.
• Hayek, F.A. 1945. The Use of Knowledge in Society. American Economic Review 35(4), pp. 519-30.
• Smith, Adam. 1776. An Inquiry into the Nature and Causes of the Wealth of Nations. In four volumes. Edinburgh.
• Temin, Peter. 2000. The Great Depression. In The Cambridge Economic History of the United States, Volume III: The Twentieth Century. Edited by Stanley L. Engerman and Robert E. Gallman. New York: Cambridge University Press, 2000
• Williamson, Oliver E. 1985. The Economic Institutions of Capitalism. New York: The Free Press.

Mark Harrison : 18 May 2009 04:23 |  Tags: Economics Universities |  Comments (3) |  Close comments |  Report a problem

Three Myths of the Credit Crunch

Three myths are current in public discussion of the credit crunch and the recession that we face today: "We should make the banks lend out the money we've given them." "We can't spend our way out of this recession." Worst of all, "We are burdening our children with debt." What's wrong with them?

We should make the banks lend out the money we've given them.

Since November the following story has been in circulation; it started from Downing Street, but has found wide support. It goes like this: We, the government, have given the banks billions of pounds of your (the taxpayers') money. Instead of translating your cash into new lending, the banks are sitting on it. This is helping to drive cash-strapped businesses into insolvency, and is not fair. The banks are breaking a moral contract. We should now set targets for bank lending and punish banks that fail to meet them.

The story's wrong. We're forgetting something. Question: What was the worst case that the bank bail-out was designed to avoid? Answer: Bank failures on a catastrophic scale. And this has been averted. Our government bailed out the banks because the alternative was a financial Armageddon on the scale that ushered in the Great Depression. So far, this worst case has been avoided. For example, no British saver has yet lost a penny from deposits in a British bank. If the worst had happened, there would be ruined savers in every neighbourhood in the country. Conclusion: the banks are doing what the bail-out intended: they are holding our cash, because they need it to hold in order to stay afloat.

If we want bank lending to increase again, our government must increase the cash available still further, or at least extend its promises. That is approximately what the government is doing now, through credit guarantees to small businesses, for example.

Another version of the same fallacy goes like this. The Bank of England's discount rate is at a record low of 1.5%. Banks (including some mortgage lenders) are unfairly increasing the margin above this level at which they are willing to lend. Public pressure or legislation should bring lending rates down. But one cause of the credit crunch is that banks have underestimated the risks of lending. As a result, the gap between their borrowing and lending rates, which includes their evaluation of risk, has been too narrow. Restoring the banking system to health must provide for larger risk premiums than before.

At this point, pressure for more bank lending and lower lending margins may not be for the best. We are in this mess because banks lent unwisely. Pressing or guaranteeing them to do more of the same, especially for the sake of small businesses that have a high failure rate even in good times, does not seem to point a way back to prudence. As has been commonly observed, monetary policy in Britain as in the United States is simply running out of ammunition. Public spending may now be more effective as a way of keeping viable businesses afloat, and should take up the burden. Which leads us to the second fallacy:

We can't spend our way out of this recession.

In 1976, prime minister James Callaghan famously remarked: "We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step." This has been widely cited recently by critics of the government such as (but not limited to) John Redwood.

If more public spending is the right answer today, why was it the wrong answer then? The reason is that that our economic predicament today is wholly different from that of Callaghan's time. In the 1970s, inflation and unemployment were rising together. That was the signal that the UK economy's problem lay on the supply side, not the demand side. The economy was rigid and uncompetitive. Industry was dominated by loss-making firms that were kept in existence by public ownership and public subsidy. The difficulties of the time required supply-side solutions: better incentives through increased competition and lower taxes.

Today, unemployment is rising and inflation is falling. This signals that the UK economy faces a deficiency of demand, not supply. Moreover, the loss of demand at home and abroad is on a scale not seen since 1929. A demand deficiency can be countered by monetary measures to some extent, but for the next few months the overworked cliché is correct: cutting interest rates is like pushing on a piece of string. (The cliché is overworked because, over a somewhat longer period, the monetary relaxation should have a powerful real effect through a more competitive sterling exchange rate.)

When demand is deficient, the quickest way to restore it may be through increased public spending. Tax cuts may be preferable in theory, since each of us knows better how to spend our money than the government does, but in the grip of current uncertainties it is likely that households will save most of any tax cut will be saved, and so the tax cuts will not contribute much to higher demand.

Rapid increases in public spending are likely to be inefficient since there is not enough time to plan them. The composition of any increase is likely to be determined more by competitive lobbying than by cost-benefit calculation. There may well be some degree of consensus that we need to invest in green technology, transport, and IT. As soon as you look at these in detail, you can watch the vested interests line up -- for and against nuclear power and carbon capture, motorway and airport expansion, and so on. However, if our immediate goal is to combat the worst consequences of the crisis, it may not matter if some projects are ill-chosen; at least they will create jobs and cash flows to replace those that are now being destroyed.

Here are two things that could and should be boosted right away -- and it would be efficient to do so.

• UK local authorities are planning for catastrophic shortfalls in council tax revenues at the same time as demands on their services are multiplying from citizens faced with losing their jobs and houses. It is shameful that local government cutbacks should be contributing to the economic downturn, rather than softening it. The government should immediately commit central funding to neutralize the effects of the recession on local government revenues.
• Iraq and Afghanistan have taken a heavy toll on the combat readiness of the UK's armed forces. The Ministry of Defence surely has a long shopping list of equipment that is needed just to reset the armed forces to their pre-conflict readiness. There is absolutely no reason to think we will need our armed forces any less in the 2010s than we did in the 1990s. We should start this restocking process now, and this will incidentally make a large contribution to the revival of UK manufacturing.

Can we use public spending to mitigate the recession? The answer lies with Obama, not Callaghan: Yes, we can.

It's true that using public spending in this way will widen the excess of spending over taxes, and cause public debt to balloon. This takes us to the third fallacy:

We are burdening our children with debt.

British politics needs an effective opposition. Just when I hoped the Conservatives were becoming one, George Osborne has come up with this: "Every child in Britain is born owing £17,000 because of Labour’s Debt Crisis."

This story is misleading, rather than false -- but it is deeply misleading on several different levels. It is true that higher public debt must be repaid sometime. As I noted here, however, the implied increase in Britain's debt implied by present policies is relatively modest and sustainable. The government deserves blame for the fact that Britain entered the recession with its current deficit in a bad way, but the accumulated level of public debt was modest, and we can easily withstand a proportionally large increase in it.

But the idea that we are burdening our children with debt is misleading at a deeper level. For one thing, they will inherit our private debts too. What is happening today will eventually lead to a considerable reduction in private debt, whether through repayment or default. At the same time public debt will be higher. So our children are likely to inherit more public debt, but less private debt.

And another thing: Our children will be better able to shoulder the public debt we will pass onto them in the future, if we don't burden them (and ourselves) with a Great Depression now. The last Great Depression impoverished families and children and threw millions of workers on the scrapheap of long-term unemployment. Worse, it paved the way to global economic disintegration and global war. Do we want to burden our children with that?

And a final thing: If it works, our children will live better than we do. As adults, they should share the burdens we face today. But I won't tell my children that. They'll say it's not fair.

Mark Harrison : 14 Jan 2009 17:05 |  Tags: Economics Keynes Recession |  Comments (4) |  Close comments |  Report a problem

In 2009, Let the Poor Have Debt

Writing about web page http://www.telegraph.co.uk/news/newstopics/religion/3981635/Bishops-deliver-damning-verdict-on-Britain-under-Labour-rule.html

Too much debt is bad. There has been too much borrowing and lending. Now we are all paying the price in bankruptcies and layoffs.

Coupled with that, a big reaction is under way against the idea of debt and the people who make debt possible: the lenders. There's a lot of anger around that is being directed against bankers. There's also a lot of ex post moralizing: the recession is poetic justice, collective punishment for past collective excess.

It's transparently obvious that we need to adjust to some painful lessons. When they created assets or bought assets that others were selling on, many bankers forgot about exercizing due diligence. They misunderestimated the risk. Those that made the biggest mistakes will have made the biggest losses, so the market has now delivered rough justice. The trouble is that, because market justice is rough, we will all suffer with them.

How far should we all adjust? When people are in a fix and feelings are running high, reactions can go too far. Over Christmas there has been a lot of opinionating about debt. Interviewed before the holiday on Radio 4, the Archbishop of Canterbury said that debt cannot be the foundation of sustainable prosperity. Although he agreed it would be "suicidally silly" for him to start dispensing economic advice, this did not stop five other Anglican bishops from issuing a Boxing Day fatwa against the "buy now, pay later" society.

So, it's time to speak up for debt. Too much debt is bad. But too little debt is bad, too. Even today, if you look at economic conditions around the world, it's almost certainly the case that the damage caused by too little debt hugely exceeds the suffering caused by too much of it.

How's that?

Scattered around the world are many profitable investment opportunities. Many of these are in poor countries; these countries are poor, precisely because many opportunities are not exploited. The poor can see many of the opportunities just as well as the rich -- in fact, often enough, better than the rich, because the opportunities are close by where the poor live: the returns to educating children and to small enterprises, for example. But can the poor take advantage of these opportunities?

It's easy to see how the rich might jump in. After all, they are rich and can afford it. The rich might not want to, though. For one thing they may not see the opportunities hidden in the midst of poverty. For another, they may not see how to make a profit for themselves; it takes a philanthropist to want to educate a stranger's daughter, or fund a competitor's business.

So, if the rich people don't jump in, what about the poor? The problem of poor people is: they're poor. 

The only way the poor can take advantage of these opportunities is by borrowing. The poor need to be able to go into debt. 

In fact, often enough, it is being unable to incur debt that keeps the poor in their place. While the poor cannot borrow, their children stay illiterate, their land stays unfertilized, and their talents remain idle.

In 2006, Muhammad Yunus was awarded the Nobel Peace Prize for his work in bringing debt to the poor. Here are the opening words of the Prize Committee's citation. "Professor Muhammad Yunus established the Grameen Bank in Bangladesh in 1983, fueled by the belief that debt is a fundamental human right. His objective was to help poor people escape from poverty by providing loans on terms suitable to them and by teaching them a few sound financial principles so they could help themselves."

(Oh -- I changed one word in the quote. Where the original reads "credit," I wrote "debt." You can check the original here. Get the difference? Bring "credit" to the poor -- you're a saint. But those who bring "debt" to the poor -- which is exactly the same thing -- are often seen as in league with the devil. Hmm.)

In poor countries, bringing debt to the poor can be immensely liberating. Poor people that cannot borrow are condemned to live in impoverishment and insecurity; they must remain at the mercy of the existing power structures. Debt lets the poor invest; it has the potential to raise the poor above their station and enable sustainable, long-run development. Yes, real development! It's true, investment is risky and not all investments will pay off. But without debt, the poor will lack even a chance of escaping poverty, for it is then certain that the poor will invest nothing and get nothing.

Yes, it's still true that too much debt is a bad thing. But no debt at all is bad too! In fact, it can be even worse!

Again: in rich countries, even poor people would sometimes like the security and pleasure of living in their own homes. They can have it, but only if they borrow. If you don't let the poor borrow, what you are saying is: Hurray for the landlords! Long live buy-to-let! Keep home-owning for the rich! For people who cannot put down the full value of a house, being able to get a mortgage is productive in a real sense: it is productive of things that we all value, of security and family life, in fact, of exactly the same "non-material" values that the bishops think has gone missing from British culture.

No, it's not a great idea to give poor people borrow more credit than they can ever repay. But to go to the other extreme and tell the poor they must wait until they have earned it -- forever, that is -- is Victorian values of the wrong kind.

The main problem our own rich country will face in 2009 and the years beyond is not too little debt. It is the composition of the debt. A huge shift is under way in Britain from private debt to public debt. Households will tighten their belts, reduce their outgoings, pay down their mortgages, and rent new homes instead of buying them. As a result, private net indebtedness will fall.

Meanwhile, the government will splurge on unemployment benefits, housing support, and capital projects. Because of the expected fall in tax revenues, the government will pay for it by borrowing. Public debt will balloon. While short term interest rates are now at an all time low, long term rates will remain high. In the future this will be a barrier to renewed growth of private indebtedness.

And that's a good thing! When anyone borrows, they should do so in the expectation of a personal gain that exceeds the interest rate; otherwise, don't do it! Making everyone, rich and poor, leap over a higher interest rate hurdle before they borrow is not a bad idea when the problem has been too much debt.

But that's just to ensure that debt performs its proper function: to sustain development. If the poor are to participate in development, they must be able to borrow. The poorest places in the world are the places where the poor cannot borrow.

Mark Harrison : 30 Dec 2008 14:23 |  Tags: Economics Keynes Recession |  Comments (0) |  Close comments |  Report a problem