An article in the Huffington Post on pirates was forwarded to me lately, and it together with some other reading and thinking present some interesting propositions about how we see the world.
Firstly to the article. It covers two points. The first is the idea that the historical pirate was a kind of revolutionary hero escaping the shackles of repressive commanders in various navies. The second is that the modern Somali pirate similarly is a kind of revolutionary hero, defending his country from the ravages of "Western Europe".
To the first point, this alternative narrative about pirates is just as misleading as the notion of the pirate as disreputable rogue. The bulk of piracy was conducted by the British Government sponsored "privateer", whose mission was the pilferring of Spanish gold. If my facts are right the British Government recognised the benefit of having the gold flow to the economy rather than specifically to the treasury. (Niall Ferguson gives this good treatment in Empire).
The second part is the claim that the Somali pirates started out as a citizen defence force protecting the Somali coastline (not otherwise defended as this was a failed state) from firstly the "Western world" which has been dumping nuclear waste off the Somali coast, and secondly from "European ships" looting the seas of their most important resource, seafood.
Well, at least these "Western Europeans" are taking their waste back in the form of seafood that glows in the dark!
What all of these demonstrate is the natural human desire to convert facts into "narratives". This desire was noted by Nassim Nicholas Taleb in his book The Black Swan (a volume I'm currently only part way through). It is a natural human way to store and manage "facts" to put them into narratives. The problem becomes that the causal links implied in the narratives are presumed to be real rather than the convenience of the "story teller".
One of the common features of the narrative process is to lump groups of people together into singular actors. Hence the pirate story features "Western Europe", while political narratives have references to actors called "the Left" and "the Right". These actors are perceived to act together as one, even though, for example, no one can find the planning meeting by which "the Left" co-ordinates its campaigns to, variously, create education syllabi to further their cause.
I was mindful of this narrative construct when writing a review (forthcoming) for the Telecommunications Journal of Australia. I note in the review that the author would be pleasing his Liberal party colleagues by his use of a narrative form of history, as a reference to at least one strand of the history wars.
What is more telling, however, is the way this fits with the reviewed book also being a piece of policy analysis from the particular view of one corporation. And it set my mind thinking that the typical "conversation" within a corporation is the narrative constructed by the management team to "explain" the events around them.
So in the sector I'm most familiar with there is the narrative that Telstra has about why certain things happen to them because of the way "the ACCC sets prices below costs". On the flip side there are narratives that ascribe sets of motivations to the actions of Telstra that are engaged in by other telcos.
The significance of these narratives is that they form the essential core of the "bounded rationality" of corporations (which I wrote about in part in this TJA article. The significance of this is that firms don't actually conciously pursue genuinely profit maximising strategies, merely the strategy that fits the narrative that is proit maximising. But as Taleb also goes to show, when we look back it looks like firms do pursue profit maximising strategies, but the reality is that this is only because, in the long run, the firms that survive are those that happened to luck onto the best strategy.
This suggests that the really great corporation is the one that can break out of its narrative. Ultimately this is what the scenario planning methodologies try to achieve (see The Art of the Long View. But a shorter route is available from pursuing Barry Nabeloff's strategy as detailed in his book Why Not?.
The warning bells should really sound when you have lots of agreement around the management or board table. That is when you have become embedded in the narrative. The alternative is to pursue the philosophy espoused by Paul Feyerabend (which is both the title of this blog and the title of a critique of the approach by David Stove) "Anything Goes". That is, conciously develop a proliferation of theories that work, and keep using them all. Don't prematurely settle on the one true narrative.
Going back to pirates and Somalia. In the end does it matter why the pirates first started to operate? Is the narrative at all helpful by explaining the cause, or is the only important factor the reality that there are pirates and their actions are now impeding the flow of aid to Somalia?
To put it another way, does the historical basis of Telstra's market power matter, or is the only important issue dealing with it.
After all, does it make sense to both (a) dump heavy metals and radioactive waste in the seas off Somalia and (b) raid the fish stocks from those same seas?
Friday, April 24, 2009
Tuesday, April 21, 2009
The Tanner Thesis - Part III
I'm not the only person to have seen the Tanner blog and commented on it admiringly, as Christian Kerr noted in yesterday's Oz;
Finance Minister Lindsay Tanner, one of the Government's sharpest minds, published a predictably thoughtful essay on the global financial crisis on a Fairfax blog last week. It shows up his boss's effort. By and large it prefers fact and reason to polemic and hyperbole.
I've covered Tanner's thoughtful contributions on economics, but he concluded with a contribution on politics. He asked;
And what does the recovery from economic crisis mean for the ideological contours which frame the political contest in developed countries?
He goes on to claim that politics since the Industrial Revolution has all been about the group versus the individual, with a political cleavage between a collectivist party and an individualist party. A student of party politics would have something to say about the actual migration of the concept of party as something based in philosophy and mass movements to the more modern version of parties motivated by power and replicating the Hotelling ice cream sellers (two ice-cream sellers on a beach will both site themselves in the middle).
There is, however, also something wrong in the depiction that at all times this was a battle between unified collectivists and unified individualists. Indeed at the philosophical and political level it is actually easier to see the history as made up of a very long period whre there was one strong philosophy against which there was an array of opposition, followed by a point at which this switched. In this conception the collectivist philosophy dominated from the late eighteenth century as the one intellectual idea and there was arraigned against it a coalition of philosophies including liberalism and strict conservatism. In the late nineteenth century this resulted in some odd occurrences such as the Tories being the ones who extended the franchise because they had more at risk from a collectivist revolution.
In the Australian context the merger of the Free Traders and Protectionists was motivated by the need to create an anti-Labor position. The early Liberals (Deakin) and the latter Liberals (Menzies) distinguished themselves by how much of the collectivist agenda they actually accepted to ensure stability rather than how much of an individualist agenda they pursued.
But events in the middle of the twentieth century brought about a significant shift. Firstly the ongoing divisions within the collectivists between the revolutionary and democratic wings took their toll on the collectivist position. At the same time the events in Europe inspired a re-examination of the role of the state as documented in Hayek's The Road to Surfdom which was a rejection of state control (both left and right) not an attack of collectivism itself.
However, the fractured position of the collectivists and the set of ideas that became attached to the Hayek warnings led to the development of the modern individualist philosophy. This went far beyong classical liberalism and included elements of Ayn Rand's libertarianism, and picked up a new collection of economic theorists including Alan Greenspan and Milton Friedman.
Most significantly from the mid 1970s on the dominant intellectual position was the individualist position and the rest fell into an anti-individualist camp, but even when that modern left came to power (Hawke/Keating) they distinguished themselves by how much of the individualist agenda they implemented (technically more than the Fraser/Howard and Howard/Costello eras).
In his book The Wrecking Crew Thomas Frank gives a good outline of the positive stance of the new era individualists, and his explanation of the high deficits from the Bush administration is that it is merely an extension of defunding the left.
Tanner thinks the absence of the communist bogey has forced the right to be more populist. It is probably more reasonable to pursue the position of John Rawlston saul that the depth of intellectual discussion on policy has escaped the capacity of the voter to analyse and hence has resulted in campaigning by slogans. But this generalisation seems to be an exercise in romanticising the past. While the early socialists were great pamphlateers the mob in the streets were mostly there to support a slogan.
The only reason why a move from populism seems to be important now is because of the sense of crisis, and people respond more to someone who tyakes a crisis seriously rather than one who takes it glibbly. Aspirational slogans are out, but the message that "we are in a crisis and we are safe hands" is still mrely populist.
Tanner under the funky heading of "Gov 2.0" suggests that;
The script for the new accommodation between governments and markets is yet to be written. The global recession is a crucial turning point. Just as the Great Depression signalled the end of laissez-faire economics in the industrial era, the current crisis will spell the end of its modern equivalent.
If there is a new script it is the one that was mentioned in Part I, the choice isn't between Government or markets it is only about what Governments have to do to make markets work. In the end making markets work also means adjusting for equity affects because without the adjustment you get various kkinds of social collapse if not outright revolution.
This is either Gov about 5.1, or it remains political theory 101. But the defining line in the last great philosophical shift was the war not the depression (though on one reading the war itselfmay not have happened without the depression).
As Tanner himself notes "Nassim Nicholas Taleb convincingly demolishes the modern conceit that we can accurately predict and manipulate the future." We can't really know if this crisis is a defining ine or not...yet.
Finance Minister Lindsay Tanner, one of the Government's sharpest minds, published a predictably thoughtful essay on the global financial crisis on a Fairfax blog last week. It shows up his boss's effort. By and large it prefers fact and reason to polemic and hyperbole.
I've covered Tanner's thoughtful contributions on economics, but he concluded with a contribution on politics. He asked;
And what does the recovery from economic crisis mean for the ideological contours which frame the political contest in developed countries?
He goes on to claim that politics since the Industrial Revolution has all been about the group versus the individual, with a political cleavage between a collectivist party and an individualist party. A student of party politics would have something to say about the actual migration of the concept of party as something based in philosophy and mass movements to the more modern version of parties motivated by power and replicating the Hotelling ice cream sellers (two ice-cream sellers on a beach will both site themselves in the middle).
There is, however, also something wrong in the depiction that at all times this was a battle between unified collectivists and unified individualists. Indeed at the philosophical and political level it is actually easier to see the history as made up of a very long period whre there was one strong philosophy against which there was an array of opposition, followed by a point at which this switched. In this conception the collectivist philosophy dominated from the late eighteenth century as the one intellectual idea and there was arraigned against it a coalition of philosophies including liberalism and strict conservatism. In the late nineteenth century this resulted in some odd occurrences such as the Tories being the ones who extended the franchise because they had more at risk from a collectivist revolution.
In the Australian context the merger of the Free Traders and Protectionists was motivated by the need to create an anti-Labor position. The early Liberals (Deakin) and the latter Liberals (Menzies) distinguished themselves by how much of the collectivist agenda they actually accepted to ensure stability rather than how much of an individualist agenda they pursued.
But events in the middle of the twentieth century brought about a significant shift. Firstly the ongoing divisions within the collectivists between the revolutionary and democratic wings took their toll on the collectivist position. At the same time the events in Europe inspired a re-examination of the role of the state as documented in Hayek's The Road to Surfdom which was a rejection of state control (both left and right) not an attack of collectivism itself.
However, the fractured position of the collectivists and the set of ideas that became attached to the Hayek warnings led to the development of the modern individualist philosophy. This went far beyong classical liberalism and included elements of Ayn Rand's libertarianism, and picked up a new collection of economic theorists including Alan Greenspan and Milton Friedman.
Most significantly from the mid 1970s on the dominant intellectual position was the individualist position and the rest fell into an anti-individualist camp, but even when that modern left came to power (Hawke/Keating) they distinguished themselves by how much of the individualist agenda they implemented (technically more than the Fraser/Howard and Howard/Costello eras).
In his book The Wrecking Crew Thomas Frank gives a good outline of the positive stance of the new era individualists, and his explanation of the high deficits from the Bush administration is that it is merely an extension of defunding the left.
Tanner thinks the absence of the communist bogey has forced the right to be more populist. It is probably more reasonable to pursue the position of John Rawlston saul that the depth of intellectual discussion on policy has escaped the capacity of the voter to analyse and hence has resulted in campaigning by slogans. But this generalisation seems to be an exercise in romanticising the past. While the early socialists were great pamphlateers the mob in the streets were mostly there to support a slogan.
The only reason why a move from populism seems to be important now is because of the sense of crisis, and people respond more to someone who tyakes a crisis seriously rather than one who takes it glibbly. Aspirational slogans are out, but the message that "we are in a crisis and we are safe hands" is still mrely populist.
Tanner under the funky heading of "Gov 2.0" suggests that;
The script for the new accommodation between governments and markets is yet to be written. The global recession is a crucial turning point. Just as the Great Depression signalled the end of laissez-faire economics in the industrial era, the current crisis will spell the end of its modern equivalent.
If there is a new script it is the one that was mentioned in Part I, the choice isn't between Government or markets it is only about what Governments have to do to make markets work. In the end making markets work also means adjusting for equity affects because without the adjustment you get various kkinds of social collapse if not outright revolution.
This is either Gov about 5.1, or it remains political theory 101. But the defining line in the last great philosophical shift was the war not the depression (though on one reading the war itselfmay not have happened without the depression).
As Tanner himself notes "Nassim Nicholas Taleb convincingly demolishes the modern conceit that we can accurately predict and manipulate the future." We can't really know if this crisis is a defining ine or not...yet.
Spectrum valuation
The Department of Broadband, Communications and the Digital Economy has issued a tender for consultants to value the expiring fifteen year spectrum licences. The exact brief is;
The Department requires a Consultant to conduct a desktop analysis to estimate the potential value that could be received by government from re-issue of the 15 year spectrum licences. A range of scenarios will be provided to the successful Tenderer. The scenarios will range from the reallocation of licences through an auction process to the renewal of licences held by incumbents. Associated issues, such as disruption costs that could result from an auction (because of the potential for new licensees and service discontinuity) will also need to be assessed.
The Consultant will review relevant international and/or Australian spectrum valuation practices, including giving consideration to the major services that are likely to use the spectrum. Value means the amount of money buyers may be prepared to pay the government to purchase the spectrum when it becomes available. Tenderers should include a description of their proposed approach and methodology.
I don't envy anyone that task. There is a particular problem inherent in the whole construction of spectrum policy and the idea of value. As the tender document also notes;
Spectrum is a valuable resource. The Radiocommunications Act 1992 aims to provide for management of the radiofrequency spectrum in order to, among other things, maximise the overall public benefit derived from using the radiofrequency spectrum. The Government is required to balance a range of social policy objectives against industry demand to achieve this outcome. .
The question always arises of how the "overall public benefit" from using radiofrequency spectrum is interpretted. In an environment of price based allocation is the "pblic benefit" limited to the income generated by the sale of the spectrum licenc, or is it something greater that would be recognised as the social benefit in a more standatrd cost-benefit analysis.
The issue is mute if the public benefits equate to the private benefits of a firm utilising the spectrum. This is not necessarily the case, as the nature of the services is that they are bedevilled with externalities. Some of these are the well-known externalities attributable to network effects. Where the spectrum is providing general communications services these are highly likely to be the kind of privte investments that produce the "spillovers" that generate growth in Paul Romer's new growth theory. In this regard evaluating the public benefit of spectrum is a task akin to measuring the public benefit of, say, the NBN.
The second problem with equating the public benefit with the private benefit as expressed by a price based allocation is one of imperfect information. If we assume that ever bidderr in an auction has imperfect informatio, we can assume that there will be a range of valuations chosen by participants that reflects the errors in their information. In a auction process the spectrum is allocated to the bidder who was most wrong in their over-valuation. In the best of all possible worlds the bidders will have discounted their bids to reflect this uncertainty, however, in the real world we are more likely to see the outcomes that occured in the second PCS auction and the LMDS auction where the amounts paid were simply unsustainable.
Finally, there is the issue of the interplay between the private and public benefit that could be partially sumarised as a consideration of market power. In its most extreme form this reflects the concept of rent seeking, a firm would be prepared to pay some of its economic rent in a higher spectrum price if it can in this way constrain the market. More generally, if the end market for services is competitive every dollar spent in acquiing spectrum is a dollar less that cen be spent on building network, so the consequence of creating a charge for the spectrum sset is to reduce output and incur a deadweight loss.
Whoever wins this consultancy has some difficult tasks ahead, some of which are dealing with entrenched views in policy areas that have equated the public benefit with the revenue received and ignoring the fact that ultimately any payment received for the spectrum comes from consumers.
The Department requires a Consultant to conduct a desktop analysis to estimate the potential value that could be received by government from re-issue of the 15 year spectrum licences. A range of scenarios will be provided to the successful Tenderer. The scenarios will range from the reallocation of licences through an auction process to the renewal of licences held by incumbents. Associated issues, such as disruption costs that could result from an auction (because of the potential for new licensees and service discontinuity) will also need to be assessed.
The Consultant will review relevant international and/or Australian spectrum valuation practices, including giving consideration to the major services that are likely to use the spectrum. Value means the amount of money buyers may be prepared to pay the government to purchase the spectrum when it becomes available. Tenderers should include a description of their proposed approach and methodology.
I don't envy anyone that task. There is a particular problem inherent in the whole construction of spectrum policy and the idea of value. As the tender document also notes;
Spectrum is a valuable resource. The Radiocommunications Act 1992 aims to provide for management of the radiofrequency spectrum in order to, among other things, maximise the overall public benefit derived from using the radiofrequency spectrum. The Government is required to balance a range of social policy objectives against industry demand to achieve this outcome. .
The question always arises of how the "overall public benefit" from using radiofrequency spectrum is interpretted. In an environment of price based allocation is the "pblic benefit" limited to the income generated by the sale of the spectrum licenc, or is it something greater that would be recognised as the social benefit in a more standatrd cost-benefit analysis.
The issue is mute if the public benefits equate to the private benefits of a firm utilising the spectrum. This is not necessarily the case, as the nature of the services is that they are bedevilled with externalities. Some of these are the well-known externalities attributable to network effects. Where the spectrum is providing general communications services these are highly likely to be the kind of privte investments that produce the "spillovers" that generate growth in Paul Romer's new growth theory. In this regard evaluating the public benefit of spectrum is a task akin to measuring the public benefit of, say, the NBN.
The second problem with equating the public benefit with the private benefit as expressed by a price based allocation is one of imperfect information. If we assume that ever bidderr in an auction has imperfect informatio, we can assume that there will be a range of valuations chosen by participants that reflects the errors in their information. In a auction process the spectrum is allocated to the bidder who was most wrong in their over-valuation. In the best of all possible worlds the bidders will have discounted their bids to reflect this uncertainty, however, in the real world we are more likely to see the outcomes that occured in the second PCS auction and the LMDS auction where the amounts paid were simply unsustainable.
Finally, there is the issue of the interplay between the private and public benefit that could be partially sumarised as a consideration of market power. In its most extreme form this reflects the concept of rent seeking, a firm would be prepared to pay some of its economic rent in a higher spectrum price if it can in this way constrain the market. More generally, if the end market for services is competitive every dollar spent in acquiing spectrum is a dollar less that cen be spent on building network, so the consequence of creating a charge for the spectrum sset is to reduce output and incur a deadweight loss.
Whoever wins this consultancy has some difficult tasks ahead, some of which are dealing with entrenched views in policy areas that have equated the public benefit with the revenue received and ignoring the fact that ultimately any payment received for the spectrum comes from consumers.
Let's change the paradigm
Gerard Henderson in today's SMH would have us believe that the failure of the Government to release information about what happened on the boat that caught fire and sank off Ashmore Reef is in conflict with the statements from John Faulkner about the importance of informing the public and the interests of democracy.
However, the reality is that the events are not clear as Henderson asserts. There are multiple witnesses and specific physical evidence. To provide information to the public rather than mere data will require what Bob Debus described to Lateline as a “forensic reconstruction.” The police are the people with the skils and resources to conduct such an investigation, not the defence force. The Government has taken the appropriate action in ensuring that occurs.
To start making definitive statements about “what happened” before that investigation would be to follow the unfortunate experience of the previous Government. The cases of children overboard and of Private Kovco should not be repeated.
It is time we changed the paradigm and expected Ministers to be fully informed not simply relay the first convenient version they find. This is not only consistent with the principles of full public disclosure, but also with the pursuit of evidence based policy.
However, the reality is that the events are not clear as Henderson asserts. There are multiple witnesses and specific physical evidence. To provide information to the public rather than mere data will require what Bob Debus described to Lateline as a “forensic reconstruction.” The police are the people with the skils and resources to conduct such an investigation, not the defence force. The Government has taken the appropriate action in ensuring that occurs.
To start making definitive statements about “what happened” before that investigation would be to follow the unfortunate experience of the previous Government. The cases of children overboard and of Private Kovco should not be repeated.
It is time we changed the paradigm and expected Ministers to be fully informed not simply relay the first convenient version they find. This is not only consistent with the principles of full public disclosure, but also with the pursuit of evidence based policy.
Friday, April 17, 2009
The Tanner Thesis - Part II
In my first post I forgot to do two things. To defend the use of mathematics and the battle Tanner will have close to his day job in his assault on "traditional economics"
Part III will be reserved for the bit on politics - which could go forever and include references to John Rawlston Saul and a host of writers on the right and left.
There is a lot of guff written about the significance of mathematical formalism in economics. Firstly there are a host of books that focus on the question of "how economics became a mathematical science". One particular thesis notes the coincidence of the development of Maxwell's equations for electromagetism and the marginalist development (Walras et al) of economics.
This coincidence of tools however does not invalidate their utility. We can engage in an endless discussion in the philosophy of science, but it is easiest just to accept the approach of Feyerabend epitomised by (this blog's title) "anything goes". Mathematics as a study itself is a process of abstract formalism. However, mathematics in use provides some powerful tools to develop models that describe the world.
The critique of the use of mathematics in economics reaches its peak in Tony Lawson's work where he asserts that the common unifying theme of heterodox economics is its rejection of ‘mathematical-deductivist methods' (to quote Hodgson who is commenting on a related Lawson paper).
In my view the idea of the rejection of the mathematics is wrong, it is the assumptions of the mathematics that is wrong. Economists have regularly compromised their theory to enable it to fit the mathematical formalism. Hence the obserrvations of behavioural economics usually get ignored because it makes life way too hard mathematically if for example demand curves are always "kinked" at the current market price (endowment effects), or if discount rates need to change over time (valuing more now than in the future). Let alone the real difficulties of the fact that real world supply curves aren't usually monotonically increasing.
But that is not a reason to reject mathematics, it is a reason to find different mathematical tools than the very simple suite of tools from simple differential calculus. The works like that of Beinhocker with discussions of complexity rather than chaos start getting to these options. There is a wealth of mathematics now being applied in biology, as the mathematics of complexity show with simple applications like the generation of leaf and landscape formations with fractals.
The attempt to distinguish between the mathematics of complexity and that of chaos is erroneous, as chaos is only a description of the behaviour of complex systems in certain boundary conditions. The beauty of these approaches is that incredibly complex outcomes can be described in relatively simple mathematical formalisms.
I noted in my post on J.K.Galbraith's death;
In the final analysis it is hard to disagree with the view expressed in the NY Times review (reprinted in the AFR) that "his sweeping ideas, which might have gained even greater traction had he developed disciples willing and able to prove them with mathematical models." It is not too late for this task.
That position I think applies to all the heterodox strands, because to be useful the economic theory ultimately needs to help us mahe quantifiable predictions about the future. To do so requires a mathematics of some kind.
The second point I wanted to make was Tanner's need to deal with behavioural economics sceptics much sloser to home, in fact, in the Productivity Commission. The PC went to the effort of hosting a roundtable on behavioural economics. However, in their Appendix B ('Behavioural economics and
consumer policy") to their Review of Australia's Consumer Policy Framework the Commission concluded;
Many of these considerations evidently apply to all regulation making, indicating that designing policy responses to the issues raised by behavioural economics is not overly different from responding to more traditional problems such as externalities and the abuse of market power.
The inclusion was interesting because at the time of the review the Deputy Chair of the ACCC was Louise Sylvan who in a speech enitled The Interface between Consumer Policy and Competition Policy tried to emphasise that mere reliance on competition policy to promote consumer outcomes may be insufficient due to some of the effects noted by behavioutral economists. Perhaps the views at the PC will change now that she is a Commissioner there instead of at the ACCC.
Certainly the public service and the economics profession continues to be wedded to its simplistic model of markets and their inacurate mathematical descriptions. It will take a lot of work to shift their perceptions.
Part III will be reserved for the bit on politics - which could go forever and include references to John Rawlston Saul and a host of writers on the right and left.
There is a lot of guff written about the significance of mathematical formalism in economics. Firstly there are a host of books that focus on the question of "how economics became a mathematical science". One particular thesis notes the coincidence of the development of Maxwell's equations for electromagetism and the marginalist development (Walras et al) of economics.
This coincidence of tools however does not invalidate their utility. We can engage in an endless discussion in the philosophy of science, but it is easiest just to accept the approach of Feyerabend epitomised by (this blog's title) "anything goes". Mathematics as a study itself is a process of abstract formalism. However, mathematics in use provides some powerful tools to develop models that describe the world.
The critique of the use of mathematics in economics reaches its peak in Tony Lawson's work where he asserts that the common unifying theme of heterodox economics is its rejection of ‘mathematical-deductivist methods' (to quote Hodgson who is commenting on a related Lawson paper).
In my view the idea of the rejection of the mathematics is wrong, it is the assumptions of the mathematics that is wrong. Economists have regularly compromised their theory to enable it to fit the mathematical formalism. Hence the obserrvations of behavioural economics usually get ignored because it makes life way too hard mathematically if for example demand curves are always "kinked" at the current market price (endowment effects), or if discount rates need to change over time (valuing more now than in the future). Let alone the real difficulties of the fact that real world supply curves aren't usually monotonically increasing.
But that is not a reason to reject mathematics, it is a reason to find different mathematical tools than the very simple suite of tools from simple differential calculus. The works like that of Beinhocker with discussions of complexity rather than chaos start getting to these options. There is a wealth of mathematics now being applied in biology, as the mathematics of complexity show with simple applications like the generation of leaf and landscape formations with fractals.
The attempt to distinguish between the mathematics of complexity and that of chaos is erroneous, as chaos is only a description of the behaviour of complex systems in certain boundary conditions. The beauty of these approaches is that incredibly complex outcomes can be described in relatively simple mathematical formalisms.
I noted in my post on J.K.Galbraith's death;
In the final analysis it is hard to disagree with the view expressed in the NY Times review (reprinted in the AFR) that "his sweeping ideas, which might have gained even greater traction had he developed disciples willing and able to prove them with mathematical models." It is not too late for this task.
That position I think applies to all the heterodox strands, because to be useful the economic theory ultimately needs to help us mahe quantifiable predictions about the future. To do so requires a mathematics of some kind.
The second point I wanted to make was Tanner's need to deal with behavioural economics sceptics much sloser to home, in fact, in the Productivity Commission. The PC went to the effort of hosting a roundtable on behavioural economics. However, in their Appendix B ('Behavioural economics and
consumer policy") to their Review of Australia's Consumer Policy Framework the Commission concluded;
Many of these considerations evidently apply to all regulation making, indicating that designing policy responses to the issues raised by behavioural economics is not overly different from responding to more traditional problems such as externalities and the abuse of market power.
The inclusion was interesting because at the time of the review the Deputy Chair of the ACCC was Louise Sylvan who in a speech enitled The Interface between Consumer Policy and Competition Policy tried to emphasise that mere reliance on competition policy to promote consumer outcomes may be insufficient due to some of the effects noted by behavioutral economists. Perhaps the views at the PC will change now that she is a Commissioner there instead of at the ACCC.
Certainly the public service and the economics profession continues to be wedded to its simplistic model of markets and their inacurate mathematical descriptions. It will take a lot of work to shift their perceptions.
Thursday, April 16, 2009
The Tanner Thesis
Lindsay Tanner has outlined a thesis in The Age today (with a longer version in what is claimed to be a blog but to me looks just like on line content).
It is a wide ranging thesis that esentially says that just because we've had a crash following globalisation doesn't mean we should try to turn back from globalisation. Instead we need to look forward to ways to make the global economy work better. There is a sense at times that Tanner wishes it could be otherwise, rather than recognising there really is no alternative to globalisation and the changes to financial markets and trade followed the developments in transportation (the container and the jet airline) and communications (most importantly fibre optic submarine cable and IP networks).
In one sense Tanner is pointing out the fallacy known as post hoc ergo proctor hoc, just because one event follows another event does not mean the first event caused the second.
Tanner claims that "mainstream economics is in crisis", and extols behavioural economics and notes that Eric Beinhocker in The Origin of Wealth promtes the idea that the economy is better framed through a biological rather than a mathematical frame.
These are perhaps valid insights, but the attack on mathematics needs to be tempered. Let's look to the valid parts. I haven't read the Beinhocker book yet, but judging by the contents (I own it) it does exactly what Tanner describes, with one chapter in particular noting that the economy is a complex system but not chaotic.
The underlying issues, the real challenges for classical (or neo-classical) economics, are three-fold. The first is the insights of behavioural economics (for an good review see Advances in Behavioural Economics), these insights are that individuals aren't the rational models of behaviour we expect. Particular deviations are that people prefer something sooner rather than deferred, they act on impulse, they value fairness, and they value something they have more than something they don't have.
The other area, not mentioned by Tanner, is the area of institutional economics which focusses on the social norms and rules that exist to underpin the economy. There are three separate strands of these, the oriinal institutional economists (Veblen and Galbraith) and then there are both the new institutional economists and the neo-institutional economists. The former (I think) are the group who following Douglas North identify the importance of property rights and the rule of law in the development of the economy, a very useful theory in development economics but attracts some strange fellow travellrs. The other group pursues a sub-strand of industrial organisation focussing on the theory of the firm and transaction cost theory.
The final area is the one that is generally called evolutionary economics and is often a fellow traveller of institutional economics. This area takes as its focus the idea that economic systems have the same evolutionary mechanism as biological systems, including the idea of a generation process and a selection process. At the level of the economy as a whole it has a link to institutional economics because the institutions are recognised as having primarily evolved rather than having been designed. At the level of the firm this gets married with the observations of Joseph Schumpeter of the process of creative destruction, that some firms succeed and others fail. In this way it has a strong link to behavioural economics because the observation is that the successful firms don't necessarily make the rational profit maximising decisions, but as a consequence of the selection process those firms that did make profit maximising decisions were successful (survived).
(That is the assumption that firms are conciously profit maximising is an example of our earlier fallacy, the fact that successful firms are the ones who make the most profit doesn't mean they are the firms who acted most rationally to do so. Indeed there is a very strong strand in strategy theory that emphasises the impossibility of being correct about the prediction of the future and hence developing strategies that optimise outcomes across the range of possible futures).
Evolution is a bit more advanced than simple trial and error but it does acknowledge the importance of chance.
The ultimate conclusion of all these alternative theories is, as Tanner states, that "markets are imperfect human artifices". More importantly markets can take many different forms, (see Reinventing the Bazaar: a natural history of markets), the rules of the markets usually evolve to meet the needs of market participants.
A good example of this is stock exchanges. When there were multiple stock exchanges in a typical country the exchanges determined their own rules. The exchanges that developed rules that built confidence in buyers and sellers attracted more custom, more custom meant more funds in the market and so more new listings on the market. The evolutionary process works so that the exchanges that survive are those with the market rules (institutions) to meet customer needs. One of the rules that evolved was about market disclosure and the need to provide reports to investors.
Over time the consolidation of the exchanges (to often one) means the competition between markets dissipates and the rules become included in legislation. Many of the major institutions evolved before legislative approaches, one particular example being the whole law of contract.
The current economic crisis has its genesis in a particular market, the market for money. Tanner rightly points out the number of international structures in place to make this market work. One of these is a thing known as the Basel convention which specified a means for determiing the capital adequacy of financial institutions. Capital adequacy refers to how much capital (equity and retained earnings) a bank (or more generally a deposit taking institution) has in relation to the loans it has made, to measure how resiliant the institution would be to the default on all those loans.
In the calculation different assets are assigned different weights reflecting the position the bank would be in if the loan did default. Because mortagage backed housing loans are - well - "as safe as houses" they are rated at 50%, the bank doesn't need to have much capital to back the loan because the assumption is that the bank gets the house and can sell it. Basel II changed the ratio of capital to risk weighted loan portfolio depending on market and operational risks, whereas the original Basel agreement specifed a single ratio of 8%. Basel II also introduced the ability to assess the risk weighting of assets, one of which was according to ratings agencies. For a full non-technical explanation see this article. (Note these are all rules to do with capital adequacy, not with liquidity. They were designed to ensure that depositors money was protected. But ultimately if the bank did have to shut its doors due to a liquidity crisis at least its net position should be positive.)
But we then face the problem of an asset price bubble as was recently seen in the US (and the rest of the world) for houses, or as was seen in the US in 1929 with equities. The central bankers can't choke off the bubble by raising interest rates generally because that prices productive investments out of the market. One solution that would be available under Basel I was to vary the risk-weighting of individual asset classes based on excessive price movements - that is, if asset values are rapidly increasing then the risk-weighting should be increased.
This isn't possible under Basel II. It also isn't possible for some securities which were taken off balance sheet, that is not included in capital adequacy calculations. That was what happened with the securitisation of mortgages. Mortgage originators were no longer DTIs (or banks) so they wouldn't have been directly affected by a decision to change capital adequacy rules. The assets that entered the banking system were the securities issued against a group of mortgages, and here the Basel II rules were seen to fail as ultimatel the ratings agencies got it wrong.
But the really important lesson is how the sophisticated financial markets actually work. A good read is A House of Cards which in its opening chapter details the ten days of the collapse of Bear Stearns. he reality is that this sophisticated market works just the same as a group of mum and dad investors at a suburban bank. In reality the supposedly knowledgable investors have no knowledge at all, so they followed a market up and rushed out when it failed.
This is encompassed well in the book Animal Spirits (which I haven't read yet) but this precis. Ultimately these markets depend on simple human factors like rust, as Shiller says "The trust in the innovative lending practices was excessive; now that trust is replaced by deep mistrust."
The first step in fixing this mess is to get everyone to agree that all markets have rules, that "laissez-faire" never really applies. It is not whether there are or aren't rules, it is how those rules are designed and what the forces are for their enforcement that count.
This would be an appropriate segue into Tanner's conclusion about the new political battle and the distinction between the left and the right - but that is another blog post.
It is a wide ranging thesis that esentially says that just because we've had a crash following globalisation doesn't mean we should try to turn back from globalisation. Instead we need to look forward to ways to make the global economy work better. There is a sense at times that Tanner wishes it could be otherwise, rather than recognising there really is no alternative to globalisation and the changes to financial markets and trade followed the developments in transportation (the container and the jet airline) and communications (most importantly fibre optic submarine cable and IP networks).
In one sense Tanner is pointing out the fallacy known as post hoc ergo proctor hoc, just because one event follows another event does not mean the first event caused the second.
Tanner claims that "mainstream economics is in crisis", and extols behavioural economics and notes that Eric Beinhocker in The Origin of Wealth promtes the idea that the economy is better framed through a biological rather than a mathematical frame.
These are perhaps valid insights, but the attack on mathematics needs to be tempered. Let's look to the valid parts. I haven't read the Beinhocker book yet, but judging by the contents (I own it) it does exactly what Tanner describes, with one chapter in particular noting that the economy is a complex system but not chaotic.
The underlying issues, the real challenges for classical (or neo-classical) economics, are three-fold. The first is the insights of behavioural economics (for an good review see Advances in Behavioural Economics), these insights are that individuals aren't the rational models of behaviour we expect. Particular deviations are that people prefer something sooner rather than deferred, they act on impulse, they value fairness, and they value something they have more than something they don't have.
The other area, not mentioned by Tanner, is the area of institutional economics which focusses on the social norms and rules that exist to underpin the economy. There are three separate strands of these, the oriinal institutional economists (Veblen and Galbraith) and then there are both the new institutional economists and the neo-institutional economists. The former (I think) are the group who following Douglas North identify the importance of property rights and the rule of law in the development of the economy, a very useful theory in development economics but attracts some strange fellow travellrs. The other group pursues a sub-strand of industrial organisation focussing on the theory of the firm and transaction cost theory.
The final area is the one that is generally called evolutionary economics and is often a fellow traveller of institutional economics. This area takes as its focus the idea that economic systems have the same evolutionary mechanism as biological systems, including the idea of a generation process and a selection process. At the level of the economy as a whole it has a link to institutional economics because the institutions are recognised as having primarily evolved rather than having been designed. At the level of the firm this gets married with the observations of Joseph Schumpeter of the process of creative destruction, that some firms succeed and others fail. In this way it has a strong link to behavioural economics because the observation is that the successful firms don't necessarily make the rational profit maximising decisions, but as a consequence of the selection process those firms that did make profit maximising decisions were successful (survived).
(That is the assumption that firms are conciously profit maximising is an example of our earlier fallacy, the fact that successful firms are the ones who make the most profit doesn't mean they are the firms who acted most rationally to do so. Indeed there is a very strong strand in strategy theory that emphasises the impossibility of being correct about the prediction of the future and hence developing strategies that optimise outcomes across the range of possible futures).
Evolution is a bit more advanced than simple trial and error but it does acknowledge the importance of chance.
The ultimate conclusion of all these alternative theories is, as Tanner states, that "markets are imperfect human artifices". More importantly markets can take many different forms, (see Reinventing the Bazaar: a natural history of markets), the rules of the markets usually evolve to meet the needs of market participants.
A good example of this is stock exchanges. When there were multiple stock exchanges in a typical country the exchanges determined their own rules. The exchanges that developed rules that built confidence in buyers and sellers attracted more custom, more custom meant more funds in the market and so more new listings on the market. The evolutionary process works so that the exchanges that survive are those with the market rules (institutions) to meet customer needs. One of the rules that evolved was about market disclosure and the need to provide reports to investors.
Over time the consolidation of the exchanges (to often one) means the competition between markets dissipates and the rules become included in legislation. Many of the major institutions evolved before legislative approaches, one particular example being the whole law of contract.
The current economic crisis has its genesis in a particular market, the market for money. Tanner rightly points out the number of international structures in place to make this market work. One of these is a thing known as the Basel convention which specified a means for determiing the capital adequacy of financial institutions. Capital adequacy refers to how much capital (equity and retained earnings) a bank (or more generally a deposit taking institution) has in relation to the loans it has made, to measure how resiliant the institution would be to the default on all those loans.
In the calculation different assets are assigned different weights reflecting the position the bank would be in if the loan did default. Because mortagage backed housing loans are - well - "as safe as houses" they are rated at 50%, the bank doesn't need to have much capital to back the loan because the assumption is that the bank gets the house and can sell it. Basel II changed the ratio of capital to risk weighted loan portfolio depending on market and operational risks, whereas the original Basel agreement specifed a single ratio of 8%. Basel II also introduced the ability to assess the risk weighting of assets, one of which was according to ratings agencies. For a full non-technical explanation see this article. (Note these are all rules to do with capital adequacy, not with liquidity. They were designed to ensure that depositors money was protected. But ultimately if the bank did have to shut its doors due to a liquidity crisis at least its net position should be positive.)
But we then face the problem of an asset price bubble as was recently seen in the US (and the rest of the world) for houses, or as was seen in the US in 1929 with equities. The central bankers can't choke off the bubble by raising interest rates generally because that prices productive investments out of the market. One solution that would be available under Basel I was to vary the risk-weighting of individual asset classes based on excessive price movements - that is, if asset values are rapidly increasing then the risk-weighting should be increased.
This isn't possible under Basel II. It also isn't possible for some securities which were taken off balance sheet, that is not included in capital adequacy calculations. That was what happened with the securitisation of mortgages. Mortgage originators were no longer DTIs (or banks) so they wouldn't have been directly affected by a decision to change capital adequacy rules. The assets that entered the banking system were the securities issued against a group of mortgages, and here the Basel II rules were seen to fail as ultimatel the ratings agencies got it wrong.
But the really important lesson is how the sophisticated financial markets actually work. A good read is A House of Cards which in its opening chapter details the ten days of the collapse of Bear Stearns. he reality is that this sophisticated market works just the same as a group of mum and dad investors at a suburban bank. In reality the supposedly knowledgable investors have no knowledge at all, so they followed a market up and rushed out when it failed.
This is encompassed well in the book Animal Spirits (which I haven't read yet) but this precis. Ultimately these markets depend on simple human factors like rust, as Shiller says "The trust in the innovative lending practices was excessive; now that trust is replaced by deep mistrust."
The first step in fixing this mess is to get everyone to agree that all markets have rules, that "laissez-faire" never really applies. It is not whether there are or aren't rules, it is how those rules are designed and what the forces are for their enforcement that count.
This would be an appropriate segue into Tanner's conclusion about the new political battle and the distinction between the left and the right - but that is another blog post.
Wednesday, April 15, 2009
Telstra and management
A great article in the AFR today by Bill Scales. Unfortunately it is behind the paywall. Bill was the former head regulatory honcho at Telstra and in this piece he speculates on what the assessment of Telstra's experiment of "outsourcing management" will be.
In large measure this is a critique of the Telstra Board because ultimately it doesn't appear that this was what the Telstra Board thought they were doing. More interestingly is the question of whether there has been any enduring change. I guess the answer is we will see.
But in the context of writing a review of Paul Fletcher's new book I was noting that in the "great man" approach to history it is often forgotten that it is the events that make the man as much as the man makes the events. How much of the last 4 years were really the culmination of events, the reaction of a fully privatised Telstra to a regulatory regime that's intent remains to confiscate rents?
I ell recall that during the benign Ziggy years the management team at Telecom New Zealand regularly told me that the fully privatised Telstra would not be as compliant. They were right. I'd argued that no sensible management team would behave the way the Telecom team said they expected Telstra to do, because it wouldn't work against Government. I was right about its futility, but not about whether it would be attempted or not.
The approach that Telecom New Zealand favoured cost them their own jobs too. They have been under new management being trying to fix the relationship with Government.
Now we see reports that Telstra is strategising on how to mend its own fractured relationship. The report also highlights just how extensive the risk to Telstra now is. Reports in the press noted that Telstra Chair Donald McGauchie was briefed on the NBN proposals and regulatory paper by Treasury secretary Ken Henry, but this was because they were together at the RBA Board meeting.
The press reported that the rest of the directors were briefed by PM&C head Terry Moran, but it appears he was joined by two other Secretaries, Patricia Scott (DBCDE) and Ian Watt (Finance). It appears the message has sunk through.
I do recall under the last Government one Minister saying to me "how many inister's does it take to counsel the chair of Telstra" as the stinging attacks mounted. It appears the answer is 4, it can be their officials, but it has to be together.
In large measure this is a critique of the Telstra Board because ultimately it doesn't appear that this was what the Telstra Board thought they were doing. More interestingly is the question of whether there has been any enduring change. I guess the answer is we will see.
But in the context of writing a review of Paul Fletcher's new book I was noting that in the "great man" approach to history it is often forgotten that it is the events that make the man as much as the man makes the events. How much of the last 4 years were really the culmination of events, the reaction of a fully privatised Telstra to a regulatory regime that's intent remains to confiscate rents?
I ell recall that during the benign Ziggy years the management team at Telecom New Zealand regularly told me that the fully privatised Telstra would not be as compliant. They were right. I'd argued that no sensible management team would behave the way the Telecom team said they expected Telstra to do, because it wouldn't work against Government. I was right about its futility, but not about whether it would be attempted or not.
The approach that Telecom New Zealand favoured cost them their own jobs too. They have been under new management being trying to fix the relationship with Government.
Now we see reports that Telstra is strategising on how to mend its own fractured relationship. The report also highlights just how extensive the risk to Telstra now is. Reports in the press noted that Telstra Chair Donald McGauchie was briefed on the NBN proposals and regulatory paper by Treasury secretary Ken Henry, but this was because they were together at the RBA Board meeting.
The press reported that the rest of the directors were briefed by PM&C head Terry Moran, but it appears he was joined by two other Secretaries, Patricia Scott (DBCDE) and Ian Watt (Finance). It appears the message has sunk through.
I do recall under the last Government one Minister saying to me "how many inister's does it take to counsel the chair of Telstra" as the stinging attacks mounted. It appears the answer is 4, it can be their officials, but it has to be together.
Oh for a palace!
There has been a bit of reporting today about the PM's gifts. All gifts to the PM over $500 in value to Minister's including the Prime Minister are handed over to the state. But all that happens is they sit in a cupboard somewhere.
The process of gift giving like this has gone on for a long time. A memorable display of it appears at Windsor Castle in the State rooms that are open for public visits. This rather ostentatious display also includes a collection of weaponry as would have graced an earlier medieval castle.
We don't have the equivalent, though maybe all these gifts could be housed at Yarralumla. But that is perhaps still not imposing enough and definitely not acessible. I don' know what Old Parliament House is used for now we have a new National Portrait Gallery - but maybe we could start a permanent display in there.
The process of gift giving like this has gone on for a long time. A memorable display of it appears at Windsor Castle in the State rooms that are open for public visits. This rather ostentatious display also includes a collection of weaponry as would have graced an earlier medieval castle.
We don't have the equivalent, though maybe all these gifts could be housed at Yarralumla. But that is perhaps still not imposing enough and definitely not acessible. I don' know what Old Parliament House is used for now we have a new National Portrait Gallery - but maybe we could start a permanent display in there.
Wednesday, April 08, 2009
A study in contrast
Two videos to compare and contrast. The first is a British Post Office video that was Crikey's video of the day today.
The second is the presentation from Pattie Maes on the "sixth sense"
The intent of this is not to make fun of the 1960s presentation, but instead to demonstrate how slow change in telecommunications really is. Yes the 1960s piece looks daggy, but doesn't the current wearable tech look daggy? Ignoring the dagginess, what part of the wideband from the 60s presentation doesn't sound like a 1990s pitch for broadband internet.
In fact the British Post Office piece (which I suspect is really 70s - it was Crikey that dated it 60s) is highly reminicent of what the Telecom Australia "Telecom 2000" report forecast in 1975. What they both missed was the PC - the realisation of the processing power that would make it into the home.
The second is the presentation from Pattie Maes on the "sixth sense"
The intent of this is not to make fun of the 1960s presentation, but instead to demonstrate how slow change in telecommunications really is. Yes the 1960s piece looks daggy, but doesn't the current wearable tech look daggy? Ignoring the dagginess, what part of the wideband from the 60s presentation doesn't sound like a 1990s pitch for broadband internet.
In fact the British Post Office piece (which I suspect is really 70s - it was Crikey that dated it 60s) is highly reminicent of what the Telecom Australia "Telecom 2000" report forecast in 1975. What they both missed was the PC - the realisation of the processing power that would make it into the home.
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