What have we learned from the GFC?

Had the pleasure to listen to John Quiggin at yesterday's Australian Economics Society seminar on "What have we learned from the Global Financial Crisis?"

By we he meant the economics profession and policy makers.

The core of the talk was basically a quick - and very good - summary of his book Zombie Economics The thesis is that there is a group of economic ideas that emerged from the failure of Keynesian economics to deal with the crisis of the 1970s (oil shock stagflation) that refuse to die. Instead, despite evidence that should kill them once and for all, they continue to roam the planet like zombies.

He collectively refers to the set of ideas as "market liberalism". There are five core ideas that he dissects;

1. The idea that the period starting with the 1980s was a "great moderation" that would see the end of the business cycle.
2. The efficient market hypothesis, that you can't use historical data to predict asset price moves because the price already includes all the available information. That is financial markets are the best possible guide to the value of assets.
3. Dynamic Stochastic General Equilibrium modeling and the inherent assumption that the economy never deviates far from equilibrium.
4. Trickle down economics and the idea that a focus on efficiency will guarantee that everyone is ultimately better off, even if equity diverges.
5. Privatisation and the belief that all economic activity is better performed in the private sector - even natural monopolies.

After he explained all of these theories, why they should be dead and how they are still emerging, in his talk he went on to cover a few bits about the economic profession that didn't make the book - and that I'm not going to do justice to here. The first was that we need to factor more of the learning of behavioural economics into microeconomic theory - less homo econimus in the theory. The second was a twin recognition of the problem of assuming markets at or near equilibrium and of the need for policy to focus on risk management.

Both the book and the lecture concluded with three statements of what is needed in economics;
1. More on realism, less on rigor
2. More on equity, less on efficiency
3. More on humility, less on hubris

The ultimate question here is whether we are just seeing the need for a few "tweaks" in neo-classical economics or the need for a fundamental revolution.

This raises the question of exactly what is "neo-classical" economics?

I referred to a great paper by Arnsperger and Varoufakis on this in discussing digital economy policy. That listed the three axioms of neo-classicism as;

1. Methodological individualism.
2. Methodological instrumentalism.
3. Methodological equilibriation.

At heart Quiggin is really endorsing not just the need to walk away from market liberalism as a philosophy, but to revise these axioms.

I take a wide view that behavioural economics, institutional economics and complexity economics are all manifestations of a "realist" economics that confronts axioms 1 and 3 with the reality that the "preferences" that determine agent choices are socially constructed by the interaction with other agents - particularly so with network effects - and that as a consequence the "system" is not only never at equilibrium but is more likely than not to have multiple not singular equilibria.

The neo-classicists themselves will point to all the ways that they might piecewise incorporate elements of a widely defined institutionalism, an excellent article by Philip Mirowski showed how this attempt ultimately fails.

That article ended with a nice piece that reads;

To attempt to portray all history as the end result of purposive constrained maximization is to make the same error as was made by early biologists who touted Darwinian evolution proved that man was the peak of the evolutionary process. Biologists now teach that there is never a peak or a maximum in evolution, which is merely a process of incomplete adaptation to circumstances that are shifting, partly as a result of past adaptations. As Victor Goldberg has wrtitten in the context of his study of contracts, "the results stemming from the establishment of new institutions or modifications in existing ones are seldom known precisely and are often widely divergent from the original expectations."

As I noted Quiggin's "we" was both academics and policy makers. The challenge of convincing academics is hard enough, but at least they should understand the theory. The problem with policy makers is that they have started to incant market theory and competition policy without any understanding.

This was a point eloquently put by Evan Jones at last year's Contesting Markets Symposium..

I think I have covered it is some of the concepts I outlined in my first submission to the Convergence Review wherein I argued for a better view of "competition policy".

I think the simplest way to describe it is that Quiggin critiques Trickle Down theory, which argued that a focus on efficiency improves life for all. The way "efficiency" is now used it has become the policy objective itself. Market Liberalism as a theory said you don't need to worry about equity because efficiency improves everyone's lot, modern policy theory doesn't even get that far.

Novae Meridianae Demetae Dexter delenda est

Innovation Economics

I have a policy that if I blog about someone I'll send them a copy of the blog post just so they know. It is useful to avoid errors and I generally think polite.

After my comment on Robert Atkinson's critique of Progressive Economics I did so and received a nice reply. In it he did two things. The first was to say he is a big fan of institutional economics and the second was a defence of "corporations". I want to comment on both.

Rob pointed me to another website for Innovation Economics. That site has a nice call to arms up front that reads;

While the U.S. economy has been transformed by the forces of technology, globalization, and entrepreneurship, the doctrines guiding economic policymakers have not kept pace and continue to be informed by 20th century conceptualizations, models and theories. Without an economic theory and doctrine that matches the new realities, it will be harder for policymakers to take the steps that will most effectively foster growth.

Fortunately within the last decade a new theory and narrative of economic growth grounded in innovation has emerged. Known by a range of terms – “ institutional economics,” “new growth economics,” “evolutionary economics,” “neo-Schumpertarian economics,” or just plain “innovation economics”: – collectively, this new economics reformulates the traditional economic growth model so that knowledge, technology, entrepreneurship, and innovation and are now positioned at the center, rather than seen as forces that operate independently.

But up to now, innovation economics, and innovation policy, has not fully been appreciated by policymakers, in large part because the dominant economic policy models advocated by most economic advisors and implicitly held by most policymakers largely ignore innovation and technology-led growth, in favor of macroeconomic issues, such as tax cuts on individuals, budget surpluses, or social spending, which at the end of the day pale in significance to innovation in driving economic growth.

In contrast, “innovation economics” recognizes the reality that a global, knowledge-based economy requires a new approach to national economic policy based less on capital accumulation, budget surpluses, or social spending and more on smart support for the building blocks of private sector growth and innovation.

Rather than focus on ensuring that prices accurately reflect costs to drive what conventional economists call allocative efficiency, innovation economists argue that the lion’s share of economic growth is determined by productivity and innovation.

Rather than focus principally on markets assumed to be in equilibrium and individuals assumed to be acting rationally in response to price signals along supply and demand curves, innovation economics recognizes that innovation and productivity growth take place in the context of institutions. In this sense it is based on the notion that it is only through actions taken by workers, companies, entrepreneurs, research institutions, and governments that an economy’s productive and innovative power is enhanced.

The neo-Schumpterian view and embrace of evolutionary economics means that we are talking far more about neo-institutional economics rather than New Institutional Economics. The former focuses on the dynamic effects of institutions while the latter identifies the role of institutions in shaping the preferences of economic actors.

The dynamic side takes us far more to the complexity issues identified by Ormerod as discussed here yesterday.

Rob and I diverged over the role of corporations. Responding to my line "Most large corporations are the opposite of innovation." To this he has replied that corporations are actually more productive than SME's and that no nation can be indifferent to the health of its large enterprises.

The productivity of a corporation and innovation are vastly different things. I discussed the concept of innovation and large IT firms some weeks ago, noting the surprising survival of IBM.

As another example of non-innovation by big firms I take the case of News Corp. Back in the 90s News was highly focussed on the issues of "convergence", as a simple read of the Shawcross biography will show. But News failed with investments in online services through Delphi and now the retreat from Myspace.

News Corp is a growing, productive, profitable firm - but it can't innovate.

In particular Myspace - a place for personal site building - got surpassed by Facebook - a place for connecting.

The innovation space is now a battle between Google and Facebook, each of which is now a big corporation. That battle has moved on with the launch of Google +. But Google is doing catch-up in creating a social dimension - though possibly adding the value of defining multiple friendship circles. But ut isn't innovation.

In general my thesis is that the policy focus needs to be on how competition and the market works, not as a device to ensure "that prices accurately reflect costs" but that they work to transmit information. I have a belief that the focus on intellectual property needs to maximise its spillovers not its private capture.

These are things that happen by focussing on "smaller" corportations - not SME's, but certainly not established TNCs.




Novae Meridianae Demetae Dexter delenda est

The economics of growth and innovation

There is an outfit in the US called the The Information Technology and Innovation Foundation. They are best described by a quote from a job ad;

ITIF is a growing non-profit, non-partisan public policy think tank committed to articulating and advancing a pro-productivity and pro-innovation public policy agenda. We believe that innovation is central to spurring economic growth and addressing key societal challenges and that public policies should actively work to support innovation, productivity and economic competitiveness. ITIF works to help policy makers understand the critical importance of innovation and innovation policy. We produce publications, hold events, meet with policy makers, speak at forums and engage in other activities to shape innovation policy.

Their policy settings put them somewhere generally into the "free market" camp, with a bit of sectoral special pleading.

The President of the ITIF Dr Robert Atkinson has just published an interesting article The Trouble with Progressive Economics in the new Breakthrough Journal. It is worth a read.

Atkinson starts by asserting that progressives are "flummoxed" by economic policy, saying;

Most can't fathom why the neoclassical economic consensus shows no sign of being overthrown despite its role in causing the greatest economic crisis since the Great Depression. Compounding their befuddlement is the fact that the era of bipartisan Keynesianism (mid-1940s to mid-1970s) out-performed the era of bipartisan neoliberalism (mid-1970s to today) along virtually every metric, including unemployment rates, GDP growth, income equality, and the trade deficit.

He suggests that progressives therefore struggle with the reality that neoclassical economics remain the north star of most economic policy makers, including many in the Obama administration.

Atkinson first defines for himself "progressive economics" and then suggests that neither it nor neo-classical is fit for the task, writing;

What passes for progressive economic doctrine today is a haphazardly updated version of mid-century Keynesianism that has largely failed to come to terms with the realities of the globalized, innovation­-powered, 21st century economy in which we live. Just as classical liberal economics was unable to respond to the challenges of the Great Depression, and Keynesianism was unable to respond to stagflation in the 1970s, neither anti-government neoliberalism, nor anti-corporate Keynesianism are fit to deal with America's present economic predicament.

I suggest Atkinson needs to get out a bit more - for heterodox economics is made up of a much wider variety than simply New Keynesians. (see note)

That said it is his general critique that is of interest, a critique that can apply equally well to neoclassical and New Keynesians.

Firstly neither has a real explanation for growth. Neoclassical growth theory refers to some outside force of technological progress whereas the Keynesian view has Government expenditure as the engine of growth. The latter can be, as it was in the sixties and seventies, when it funds R&D and knowledge. He rightly notes that progressive economics has "focused less on promoting growth and more on fairly distributing its fruits" so "what passes for a progressive growth agenda mostly remains a redistribution agenda."

I wouldn't back away from the need for the progressives to point out how inequitable neoclassical theory is, in particular its definition and pursuit of efficiency. I also wouldn't back a Green agenda of labelling "growth" per se "bad", growth is the only way to make the less well off better off without doing a Robin Hood.

And so Atkinson concludes;

the progressive canon still lacks a coherent or credible theory for how to spur productivity, innovation, and competitiveness. Little wonder that many voters find the neoclassical story, flawed as it is, more appealing: it at least claims to produce a larger pie. ...

Developing a credible growth agenda will require progressives to fully embrace efforts to accelerate technological innovation and productivity growth. The best scholarship today identifies knowledge, technology, entrepreneurship, and innovation as the primary drivers of long-term economic growth. Over the long-term, innovation (the development of new products, services, processes, and business models) creates jobs and enables higher wages and lower prices. Moreover, sustained increases in rates of innovation and productivity growth likely represent the only long-term path to equitable growth and a sustained social welfare state in an increasingly competitive and globalized economy.

But innovation does not simply materialize out of thin market air. In fact, sustained government investment was required to produce many of the big innovations we take for granted, from the steam engine to the Internet to the iPhone. Unfortunately, progressive Keynesians, like neoclassical economists and a large swath of the American political elite, tend to ignore the government's role in proactively spurring innovation. Neoclassical economists have an excuse: they believe the market drives innovation and that governments need not get involved since government interference in markets only makes matters worse.

With this I agree. I part company with Atkinson when he says;

Supporting innovation and productivity will, by necessity, require progressives to support corporations. The vast majority of jobs and economic activity are in the private sector. In fact, most small business jobs, especially the "Main Street" jobs progressives claim to love, are fundamentally dependent upon the health of corporate manufacturing and the technology sector. As such, improving the productivity and growth rate of the US economy requires helping private firms, including corporations, become more productive and innovative. Unfortunately, progressives today overwhelmingly view businesses, especially large multinational corporations, as part of the problem, not the solution.

Most large corporations are the opposite of innovation.

There are three strands that need to be developed for an Atkinson style "progressive economics".

1. An understanding of "managerial capitalism"
Capitalism as a theory is founded in the concept of a unitary producer who accumulates capital. The reality is firms which are an agglomeration of "capital" and the issue of the principal/agent problem occurs - do managers do what shareholders want. This has been very poorly resolved by defining a purpose of the firm to "create shareholder value" and managers to manage to the share price. Firms need to exist for a market purpose and the thing shareholders want from managers is entrepreneurship to perform that purpose better.

2. An understanding of the source of profit
Basic economics talks of production functions that convert labour, capital, entrepreneurship and land (or resources) into goods. But all modelling tends to be focussed on just two dimensions of capital and labour. This conveniently enables two dimensional diagrams, but is more driven by the apparent ease of measuring quantities of labour and capital compared with the other two inputs. In reality "capital" isn't as simply quantified as it might seem, and labour has an annoying problem of being not of a uniform quality.
Indeed land can be treated as a special kind of capital and entrepreneurship as a special kind of labour, but both make the elegant mathematical models of the neo-classicist impossible to construct.

3. An understanding of the benefit of "spill-overs".
To the extent there is a growth theory that accounts for innovation it is Romer's New Economic Growth Theory. This explicitly allows for the fact that an innovation by a firm has some "public good" characteristics - others benefit from it. This runs counter to corporate thinking which is about their right to fully retain the benefit of innovation.
This issue is worse when it is added to the university sector and the desire for "commercialisation".

New Keynesians might struggle, but Neo-institutionalists (not New Institutionalists) wouldn't. This lot are also known as evolutionary economics and study the dynamics of markets and industries.

That would lead to an understanding of the need for a competition policy that focusses on externalising transactions, an intellectual property regime that does not grant excessive rights and an R&D policy that does not try to commercialise public investments.

Note: Interested readers may find out more at the website for the Association for Heterodox Economics. Their forthcoming conference features Australia's own Lynne Chester on regulation. There is one paper I'd really like to hear Dennis Badeen, Ontology and Pluralism: A cognitive map of ontologies in economics and the critique of neoclassical economics


Novae Meridianae Demetae Dexter delenda est

More on markets and property rights - tobacco

Ever since Ronald Coase created the foundations of the New Institutional Economics with his papers on the theory of the firm and social cost, a body of work has developed that has equated economic growth and progress with the creation of "property rights".

Douglass C. North is probably the foremost exponent of the application of the concept in economic history and development.

Many of the economists of the "new right" championed the importance of "property rights", none more so than Milton Friedman in his Capitalism and Freedom, which linked the economic theory of competition/choice to the political idea of freedom.

But the important point to be drawn from the Inquisitional view is that property rights are, in fact, a social construction. This is less easy to see with tangible goods, but even there the "right" to exclusive ownership is a relatively recent creation (England's enclosure happened between 1760 and 1820).

It is more obviously a social construction with respect to intellectual property. The creation of both copyright and patent protection are political acts. The inexact nature of both is legendary, and the facility with which the law has been changed equally so. The infamous "Mickey Mouse" clauses that extend the period for which copyright endures after the creators death are the best example.

This brings us to the extraordinary campaign by Big Tobacco against plain packaging legislation. Firstly there is the ad campaign trying to push the "Nanny State" line. As this ABC news report shows the companies are wise to care - after all the US is now implementing the Australian graphic images approach and the UK is following the take the product off display approach.

But there has also been the big threat of legal action, notably under section 51(xxxi) of the constitution - the infamous "vibe of the thing" clause as celebrated in the movie The Castle.

But now Phillip Morris is evidently going early using a clause in a trade agreement with Hong Kong to argue a case that the proposed law infringes their intellectual property. The reality is these clauses are inserted in trade agreements to protect against software piracy and brand name faking.

But the appeal of their case is that people interpret it as a "battle for commercial freedom". And hence we see the link back to the idea created by Friedman.

So let's get this clear from a theory and policy point of view. Property rights are social constructions. The clear allocation of property rights facilitates trade, markets and economic activity.


But clarity of property rights does not equate to a presumption of unrestrained property rights. When you buy land you do so subject to the planning laws about what you can build on it.

Let's imagine the case where the government decided to make tobacco an illegal drug. Would the tobacco companies make the same claim about the infringement of their property rights in the brand.

Let's try something simpler. A drug company invests in the IP of R&D from a drug, they invest in the clinical trials and then they invest in branding it. Let's call the drug Thalidomide. The company then markets the drug only to discover that the drug is directly responsible for birth defects.

The Government bans the drug. Does the drug company have a case for the loss of all that IP?

You may rightly point out that the drug company is at risk from a legal action - I think it is a tort - for the damage the drug caused so it removed the product itself. But that doesn't change the logic.

The property right in a brand is a social construction that it is the gift of the "polity" to restrain, so long as that is an action taken for a public not a commercial purpose.


Novae Meridianae Demetae Dexter delenda est