the hubris of economics

The hubris of economics
Barry Ritholtz | Nov 4, 2009

Given the failures of the profession — failing to anticipate the worst recession in decades, missing the warping effect of the housing boom, not recognizing the credit collapse until too late — a damning indictment of the dismal science might have been more appropriate.

Perhaps I can be of assistance.

There are many areas I would have liked to see the Economics Crisis article explore: The lack of Scientific Method, the mostly awful performance of economists, its misunderstanding of the value of modeling, the bias inherent in Wall Street variant of economics, and lastly, the corruption of economics by politics. I will just touch on some of these; you can fill in much of the blanks yourself.

Let A Hundred Theories Bloom

Let A Hundred Theories Bloom – International Business Times -
By Joseph E. Stiglitz
Oct 26, 2009 @ 02:51 pm

The economic and financial crisis has been a telling moment for the economics profession, for it has put many long-standing ideas to the test. If science is defined by its ability to forecast the future, the failure of much of the economics profession to see the crisis coming should be a cause of great concern.

But there is, in fact, a much greater diversity of ideas within the economics profession than is often realized. This year’s Nobel laureates in economics are two scholars whose life work explored alternative approaches. Economics has generated a wealth of ideas, many of which argue that markets are not necessarily either efficient or stable, or that the economy, and our society, is not well described by the standard models of competitive equilibrium used by a majority of economists.

Behavioral economics, for example, emphasizes that market participants often act in ways that cannot easily be reconciled with rationality. Similarly, modern information economics shows that even if markets are competitive, they are almost never efficient when information is imperfect or asymmetric (some people know something that others do not, as in the recent financial debacle) – that is, always .

A long line of research has shown that even using the models of the so-called “rational expectations” school of economics, markets might not behave stably, and that there can be price bubbles. The crisis has, indeed, provided ample evidence that investors are far from rational; but the flaws in the rational expectations line of reasoning-hidden assumptions such as that all investors have the same information-had been exposed well before the crisis.

China Consolidates Its Lead in Global Trade

China Consolidates Its Lead in Global Trade – NYTimes.com

“Although world trade declined this year because of the recession, consumers are demanding lower-priced goods and Beijing, determined to keep its export machine humming, is finding a way to deliver.

The country’s factories are aggressively reducing prices — allowing China to gain ground in old markets and make inroads in new ones.

The most striking gains have come in the United States, where China has displaced Canada this year as the largest supplier of imports.”

Economists for an Imaginary World

Bringing Economic Theory Back Down to Earth – washingtonpost.com
By Harold Meyerson
Wednesday, September 30, 2009

“The worldly philosophers” was economist Robert Heilbroner’s term for such great economic thinkers as Adam Smith, Karl Marx, John Maynard Keynes and Joseph Schumpeter. Today’s free-market economists, by contrast, aren’t merely not philosophers. They’re not even worldly.

Has any group of professionals ever been so spectacularly wrong? Pre-Copernican astronomers and cosmologists, I suppose, and for the same reason, really: They had an entire, internally consistent, theoretically rich system that described the universe. They were wrong — the sun and other celestial bodies save the moon didn’t actually revolve around the Earth, as they insisted — but no matter. It was a thing of beauty, their cosmic order. A vast faith was sustained in part by their pseudo-science, a faith from which such free thinkers as Galileo deviated at their own risk.

As it was with the pre- (or anti-) Copernicans, so it is with today’s mainstream economists. Theirs is an elegant system, a thing of beauty in itself, as the New York Times’ Paul Krugman has argued. It just fails to jell with reality. And unlike the pre-Copernicans, whose dogma posed a threat to those who challenged it but not, at least directly, to anyone else, their latter-day equivalents in the economic profession pose a clear and present danger to the well-being of damned near everyone.

The problem with contemporary economics, at least with the purer strain of free-market economics associated with the University of Chicago, is not simply that it failed to predict the near-collapse of the world financial system last year. The problem is that it believed such a collapse could not happen, that all risk could be quantified by mathematical models and that these quantifications could help us correctly price just about everything. Out of this belief arose the banks’ practice of securitization, which put a value on all manner of mortgages and enabled buyers to purchase and swap them with the certainty that such transactions reflected an accurate judgment of the value of the properties and the risks associated with them.

Except, they didn’t…

read more…

human brains evolving, but why?

This post is dedicated to those who think too much.

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Study finds humans still evolving, and quickly — latimes.com

“In the last 5,000 to 10,000 years, as agriculture was able to support increasingly large societies, the rate of evolutionary change rose to more than 100 times historical levels, the study concluded.

Among the fastest-evolving genes were those related to brain development, but the researchers aren’t sure what made them so desirable, Hawks said.”

Towards a better measure of well-being

FT.com / Comment / Opinion -
Towards a better measure of well-being
By Joseph Stiglitz
Published: September 13 2009

A political leader attempting to promote the well-being of his citizens is pulled in different directions: he will be graded on economic performance but there are many other dimensions to the quality of life, including the state of the environment. While there is no single indicator that can capture something as complex as our society, the metrics commonly used, such as gross domestic product, suggest a trade-off: one can improve the environment only by sacrificing growth. But if we had a comprehensive measure of well-being, perhaps we would see this as a false choice. Such a metric might indicate an increase in wellbeing as the environment improved, even if conventionally measured output went down.

Update:

From the Commission on the Measurement of Economic Performance and Social Progress home page:

Here’s a provisional draft summary of the commission’s work…

Stiglitz Urges End to GDP ‘Fetish’ / Warns banking problems now bigger than before…

Stiglitz Urges End to GDP ‘Fetish’ in Favor of Broader Measures - Bloomberg.com
By Mark Deen and David Tweed

Sept. 13 (Bloomberg) — Joseph Stiglitz, the Nobel Prize- winning economist, urged world leaders to drop an obsession with examining gross domestic product and focus more on broader measures of prosperity.

“GDP has increasingly become used as a measure of societal well-being and changes in the structure of the economy and our society have made it increasingly poor one,” Stiglitz said in an interview today in Paris.

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Stiglitz Says Banking Problems Are Now Bigger Than Pre-Lehman – Bloomberg.com
By Mark Deen and David Tweed

Sept. 13 (Bloomberg) — Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

Reshaping financial sector DNA

FT.com / Columnists / GillianTett -
Could ‘Tobin tax’ reshape financial sector DNA?

Some three decades ago, James Tobin, the economist, first proposed introducing a tax on financial transactions to deter short-term currency speculation.

Few policymakers have dared air that idea in the intervening years, since it seemed wildly unfashionable. But earlier this month Adair Turner, the chairman of the Financial Services Authority, participated in a round table organised by Prospect magazine and suggested a new debate about the old “Tobin” idea.

Unsurprisingly, this has grabbed attention, particularly in a quiet August. However, the really interesting thing about Lord Turner’s suggestion is the wider intellectual impetus behind it. For, as the FSA chairman surveys the financial crisis, he is increasingly convinced that western policymakers are at a crucial intellectual watershed.

In recent years, he argues, “the whole efficient market theory, Washington consensus, free market deregulation system” was so dominant that it was somewhat like a “religion”. This gave rise to “regulatory capture through the intellectual zeitgeist”, enabling the banking lobby to swell in size and power.

But now, he says, there has been “a very fundamental shock to the ‘efficient market hypothesis’ which has been in the DNA of the FSA and securities and banking regulators throughout the world”.

Hence, “the idea of that more complete markets were good and more liquid markets are definitionally good” is no longer trusted. “[This crisis] requires a very major reconstruct of the global financial regulatory system, [not] a minor adjustment,” he concluded during the Prospect discussion (in which I also participated).

Reflect on those words for a moment. Lord Turner previously worked at McKinsey, the management consultant group that has recently been a key evangelist for the creed of shareholder value, free-market competition and financial capitalism. Yet he now thinks that the intellectual compass-cum-bible that has guided the FSA – and McKinsey – has been wrong.

Now a cynic might attribute some of this to mere political posturing. The FSA, after all, has faced criticism for failing to get tougher in curbing banking bonuses, and in also fending off proposals to put it under the Bank of England. Yet, if nothing else, Lord Turner’s comments are a striking sign of the times. And they raise a crucial question: namely what type of intellectual framework should western regulators now use, if their prior bible – or compass – has now turned out to be so flawed?

read more…

Revisiting the Tobin Tax

This discussion is a good companion piece for an earlier post linking to information on the growth of the financial services sector…

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Revisiting the Tobin Tax – Financial Transaction Taxes for Burden Sharing and as Regulatory Tools | Re-Define

Tobin taxes are back in circulation again. The financial crisis has highlighted the fundamental problems of financial stability as well as the costs associated with bailouts of the financial sector.

Interestingly the family of tobin taxes, better known as financial transaction taxes ot security transaction taxes are good tools which can help tackle both of these problems. Their potential and role in helping provide solutions to the challenges confronting us are discussed briefly in this policy note here. This note which was written a while back will be followed by a Re-Define Policy Paper out next week.

Exponentially expanded financial markets
It is widely known that turnover in financial markets (the total value of financial instruments traded every year) has grown exponentially. This has been the case for almost all financial markets both on-exchange such as stock markets and off-exchange such as OTC derivate markets.

Currency market turnover for example rose from about $4 trillion in the 70s to $40 trillion in the 80s to more than $500 trillion now. Turnover in equity markets registered a seven fold increase between 1993 and 2005 to about $51 trillion and the wealth held in the global bond market is more than $60 trillion now with turnover substantially higher. The notional value of OTC credit default swaps, just a single kind of derivate, rose to more than $60 trillion from almost nothing a decade ago.

It is also well-understood now that this rapid rise in turnover is not unambiguously positive. Those who insisted that this rise in turnover was an indication of higher liquidity have been proven wrong by the financial crisis. Liquidity comes from having a diversity of participants and views in the financial markets with the number of trades being only one part of it.

Clearly financial markets and financial market participants have been the winners of globalization and now are the recipients of trillions of dollars of tax payer bailouts. Having already not paid their share of taxes in the past and having generated enormous wealth for themselves, these financial market participants are likely to escape paying a fair share of their tax burden in the future with the ‘little people’ left to bear the brunt of the costs of the bailouts.

Taxing financial transactions for a fairer burden sharing arrangement
One of the answers to this question no doubt has to be the taxation of financial transactions. This clearly has a tremendous potential to generate revenue at even very low levels (a few basis points) of taxation simply because the volume of transactions is so high. Our first estimates show that such taxes could easily raise predictable, stable, easy to collect and equity enhancing revenues in the range of hundreds of billions of dollars annually.

This money could then be used in a variety of ways – for example to reduce other taxes such as income taxes especially on the lowest levels of income, to repay the borrowings of governments which have expanded massively since the financial crisis hit or less ambitiously merely as an additional tool in the portfolio of taxes that most modern governments levy. All of these would result in a fairer burden sharing across citizens belonging to various income groups.

read more…

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Turner Wades Into Political Debate With Tobin Tax

Bloomberg – Caroline Binham – ‎Aug 27, 2009‎

FSA Chairman Adair Turner proposed a “Tobin Tax” on banking deals in a Prospect magazine interview. This would redistribute bank profits to the poor and to …

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AFL-CIO, Dems push new Wall Street tax

The Hill – Alexander Bolton – ‎Aug 31, 2009‎

At the end of July, shortly before the House broke for the August recess, defazio introduced legislation that would impose a 0.2 percent transaction tax on …

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Brazil eyes new tax to offset falling revenue

Reuters – Raymond Colitt – ‎Aug 25, 2009‎

BRASILIA, Aug 25 (Reuters) – Brazil’s governing coalition in Congress will push to approve a new financial transaction tax to help offset …

Krugman gets it

Hopefully, Americans will begin to see that national debates cloaked in the rhetoric of market freedoms are about anything but protecting a level market playing field with low entry barriers. What we see are players with very, very strong market positions working diligently to protect vested interests, to subvert the intent of anti-trust law and to retain and consolidate anti-competitive advantage. For small-enough-to-fail rural counties like Humboldt this is critical. Development of locally owned businesses and local employers capable of competing in regional, national and global markets without exploiting local labor and resources requires policy support that “gets it.”

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Paul Krugman – Missing Richard Nixon – NYTimes.com

But there’s another reason health care reform is much harder now than it would have been under Nixon: the vast expansion of corporate influence.

We tend to think of the way things are now, with a huge army of lobbyists permanently camped in the corridors of power, with corporations prepared to unleash misleading ads and organize fake grass-roots protests against any legislation that threatens their bottom line, as the way it always was. But our corporate-cash-dominated system is a relatively recent creation, dating mainly from the late 1970s.

And now that this system exists, reform of any kind has become extremely difficult. That’s especially true for health care, where growing spending has made the vested interests far more powerful than they were in Nixon’s day. The health insurance industry, in particular, saw its premiums go from 1.5 percent of G.D.P. in 1970 to 5.5 percent in 2007, so that a once minor player has become a political behemoth, one that is currently spending $1.4 million a day lobbying Congress.

That spending fuels debates that otherwise seem incomprehensible. Why are “centrist” Democrats like Senator Kent Conrad of North Dakota so opposed to letting a public plan, in which Americans can buy their insurance directly from the government, compete with private insurers? Never mind their often incoherent arguments; what it comes down to is the money.

Given the combination of G.O.P. extremism and corporate power, it’s now doubtful whether health reform, even if we get it — which is by no means certain — will be anywhere near as good as Nixon’s proposal, even though Democrats control the White House and have a large Congressional majority.

And what about other challenges? Every desperately needed reform I can think of, from controlling greenhouse gases to restoring fiscal balance, will have to run the same gantlet of lobbying and lies.

I’m not saying that reformers should give up. They do, however, have to realize what they’re up against. There was a lot of talk last year about how Barack Obama would be a “transformational” president — but true transformation, it turns out, requires a lot more than electing one telegenic leader. Actually turning this country around is going to take years of siege warfare against deeply entrenched interests, defending a deeply dysfunctional political system.