It must be a sign of the times that one of the central themes to emerge from a discussion I chaired yesterday evening was the urgent need for more effective corporate governance. The participants in the debate, organised by think-tank Demos and the Open Society Foundation, were ‘Blue Labour‘ thinker Lord Maurice Glasman, economist John Kay, and Dan Leighton of Demos. The essay question was whether free market ideology was compatible with an open society.

I had expected there to be quite a lot of disagreement between John Kay and the other speakers. John is a brilliant economist – both analytically rigorous and at the same time evidence-driven, with a wide knowledge of how business and finance work in practice and widely read in history and other social sciences. However, he is an economist, and our methodological perspective is distinctive and frequently disliked by non-economists – especially those on the left-of-centre.

Surprisingly, there was an unexpected and interesting consensus in the discussion. It was that policy and research alike have overlooked the importance of the institutional layer that is neither state nor ‘market’ (ie impersonal monetary transactions). A wide range of institutions and relationships shape economic outcomes. Much of the discussion focussed on financial markets and banks, and my goodness there is much unfinished business there. But other kinds of business corporations constitute an important element – and here is where the corporate governance angle came in. Lord Glasman diagnosed a need for a balance of power between owners, managers and workers. The few economists present saw a related need to reduce market concentration and reinvigorate what John described as the ‘disciplined pluralism’ of the competitive market economy – takeovers and concentration of market (and political) power being an aspect of executive rent-seeking. So the meeting agreed, to paraphrase the chant from demonstrations of old: “What do we want? Better corporate governance  – now!”

We were told by staff at the venue, 61 Whitehall, that the room in which the meeting was held had been Henry VIII’s bedroom, with separate doors for his wife and his mistress. I’m not sure whether that contributed to the atmosphere. Having ended up with a cosy agreement, the books by Maurice Glasman – [amazon_link id=”185984071X” target=”_blank” ]Unnecessary Suffering[/amazon_link] – and John Kay – [amazon_link id=”0140296727″ target=”_blank” ]The Truth About Markets[/amazon_link] – set out some intellectual disagreements. Both well worth a read.

[amazon_image id=”185984071X” link=”true” target=”_blank” size=”medium” ]Unnecessary Suffering: Management, Markets and the Liquidation of Solidarity[/amazon_image]

[amazon_image id=”0140296727″ link=”true” target=”_blank” size=”medium” ]The Truth About Markets : Why Some Countries are Rich and Others Remain Poor[/amazon_image]

A guest review by Ian Bright

[amazon_link id=”0230299857″ target=”_blank” ]Minding the Markets: An Emotional Finance View of Financial Instability[/amazon_link] by David Tuckett

Emotions affect how people behave. People do not necessarily behave rationally as basic economic models suggest. As a result, individual transactions may not maximise utility and markets may not move towards or reach equilibrium. These statements are not controversial. Behavioural economics has been studying these effects and challenging standard economic theory for at least the past two decades.

David Tuckett argues this challenge does not go enough. He asserts (pages 12 and 13) that behavioural economics is limited. It “wants to improve the field of economics on its own terms, modifying one or two assumptions that are not central”. He argues: “A purpose of this book is to show that once uncertainty is properly included, just about everything changes.” Tuckett, a Professor of Psychoanalysis at UCL, argues: “Behavioural economists do not take anything from real life psychology and neurobiology that is relevant to the task of considering the impact on human agents, working in social groups, making decisions under uncertainty.” He focuses on financial markets, partly due to personal experience and topicality, and also because these markets are supposedly seen by economists as more rational than other markets  – or at least that irrationality here can be exploited creating “a role for professional investors”.

So far, so good. But skip to page 184:

“The central implication of emotional finance is that, if the future is taken as inherently uncertain, conventional equilibrium modelling isn’t a useful way to start and, especially as far as understanding instability, isn’t helpful. Nonetheless, there may be possible ways to widen the framework of analysis to take account of my findings while still achieving a more general analytical framework. One potentially useful innovation in this area is agent-based modelling, derived from the attempts of physicists to predict the behaviour of very complex systems.”

This comes after extensive analysis of interviews with 52 international fund managers during the first eight months of 2007. Concepts such as groupfeel rather than groupthink are introduced. People and institutions are described as being in divided states, apparently as a way they try to rationalise what is actually happening with what they think should be happening. People develop stories to simplify complex decisions and cope with uncertainty. Furthermore, financial contracts have special emotional effects because they are intangible and can become ‘phantastic’ objects.

I am at a loss as to what is added by these observations. They appear to be essentially the same as well-known ideas such as herd behaviour, decision making by rules of thumb, and confirmation bias (seeking data that supports your ‘story’ and ignoring contrary evidence). And then after 180 pages, I’m anyway told that perhaps I should be reading about agent-based modelling, another familiar idea already used by a (small) number of economists.

I feel conned. Several aspects of the research approach and the argument make me uncomfortable.

Interviews can be difficult to interpret but I supposed the professor has an advantage given his professional training. Still, I was surprised to read (page 72) that only the last eight interviews were adjusted to take direct account of remuneration and performance assessment: “Because my main focus in the interviews was on describing decision making, at first I did not realise what I was seeing.” Apart from being concerned about the consistency of the “data gathering” associated with an interview technique when the questions can appear to change, I was surprised that pay was not central from the beginning.

The concept of ‘phantastic’ objects is also unconvincing. Financial products may be intangible and volatile but they are not the only objects that experience rapid price increases and declines – “bubbles” if you must. Physical items such as housing, wine, stamps and tulip bulbs have all experienced “bubbles”.

I am also concerned that Tuckett has inadvertently interviewed the wrong group of people. Fund managers were pawns in the latest financial crisis. I suspect they will be in the next as well. A more appropriate group would have been risk managers in banks and insurance companies who didn’t recognise the risks they were running, the financial engineers, derivatives traders and salespeople who made, traded and sold the complex products and the regulators and central bankers who dropped the ball. Now, there is a group for psychoanalysis.

For those who would like to hear more, the Institute for New Economic Thinking has a 15 minute video interview in which Professor Tuckett explains his ideas. It covers the main aspects of his book adequately.

Ian Bright

I am writing in a personal capacity

[amazon_image id=”0230299857″ link=”true” target=”_blank” size=”medium” ]Minding the Markets: An Emotional Finance View of Financial Instability[/amazon_image]

On holiday in France last week, I spotted an advert in Madame Figaro encouraging readers to continue to shop at their local bookstore. “With millions of books to choose from, who will help me decide if my bookshop is no longer there?” runs the copy.

Evidently, online sales are endangering bricks and mortar bookshops there too. What’s interesting about this familiar tale of decline – Borders in the US, Waterstones struggling in the UK – is that it’s always portrayed as the result of changing consumer habits. However, publishers play a part too. They choose how big a discount from the cover price of a book to give to different retail outlets. A combination of the market power of the biggest retailers – Amazon, some supermarkets – and the lower cost of distribution to their centralised warehouses means that publishers have always given bigger discounts to these outlets. The obvious consequence is that small bookstores can’t match the prices offered by their big competitors. As a particular title is the same everywhere, it’s no wonder consumers have changed their habits. If physical bookstores matter to publishers in the long term, as all publishers tend to claim, the publishing industry will need to change its habits too.

Meanwhile, here is the lovely bookshop in Toulouse which benefited from a few of my euros.

The Ombres Blanches bookstore in Toulouse

Tomas Sedlacek’s [amazon_link id=”0199767203″ target=”_blank” ]Economics of Good and Evil: The quest for economic meaning from Gilgamesh to Wall Street[/amazon_link] looked like a good way to make the transition from work to vacation, so it was my first poolside read on holiday. It had been well reviewed by Samuel Brittan in the Financial Times. I’m also a sucker for anything to do with [amazon_link id=”014044100X” target=”_blank” ]Gilgamesh[/amazon_link], from the epic itself to the brilliant Australian novel [amazon_link id=”1843541831″ target=”_blank” ]Gilgamesh[/amazon_link] by Joan London.

Back to Sedlacek, whose author picture shows him to be rather stylish for an economist, and was an adviser to Vaclav Havel. The first part of the book traces certain economic concepts from ancient times to Adam Smith. Thus for example, he attributes the first macroeconomic forecast to Joseph’s dream about the seven years of plenty and famine. He sees Plato’s theory of forms as the philosophical origin of the concept of an economic model as the hidden true structure underlying reality. He discusses the differences between the stoics and the hedonists in Ancient Greece, and traces the utilitarianism of economics to hedonism. Utility is judged by results, and is judged from the point of view of the individual. By contast, the stoics judged morality by concordance with rules. Adam Smith, Sedlacek argues, was much more in favour of the latter view, emphasising the correctness of the act itself.

In this, the author joins other recent reclamations of Adam Smith from the free market fundamentalists, including Emma Rothschild’s [amazon_link id=”0674008375″ target=”_blank” ]Economic Sentiments [/amazon_link]and Nicholas Phillipson’s new biography of Smith, [amazon_link id=”0140287280″ target=”_blank” ]Adam Smith: An Enlightened Life[/amazon_link]. This part makes the book a good complement to Sandmo’s [amazon_link id=”0691148422″ target=”_blank” ]Economics Evolving[/amazon_link], which covers the period from Adam Smith onwards.

The second half of Economics of Good and Evil turns to a discussion of the themes emerging from the historical account (a structure that actually makes for repetitiveness). Sedlacek argues that the perpetual debate in economics is a philosophical one – are humans good or evil at heart? Schools of economics differ over whether we can rely on the uncoordinated free will of many individuals to lead to good outcomes, or rather do we need for coordination from above. Does free activity lead to good or evil results?

He also asks how did economics change from being an area of moral philosophy to a mathematized allocative science, and traces this to Mandeville’s [amazon_link id=”0865970750″ target=”_blank” ]Fable of the Bees[/amazon_link]. Sedlacek writes: “I would like … to express my reservations against the belief among economists that mathematics is able to contain and describe the whole real world.” (p288). I don’t think that most economists believe this, certainly not now if they ever did (see [amazon_link id=”0691143161″ target=”_blank” ]The Soulful Science[/amazon_link]). However, it is a common trope. Sedlacek, like Richard Bronk In [amazon_link id=”0521735157″ target=”_blank” ]The Romantic Economist[/amazon_link], would like economists to include history and philosophy and even poetry in their approach to the economy. At one level this is unarguable – economists certainly ought to know history, including the intellectual history of their own discipline, and other relevant disciplines such as the other social and human sciences. A widely read and broadly educated economist will be a better economist. However, I would argue that if economics were to ditch its own methodology for the methodology of history or philosophy, it would no longer be economics.

The author also has a rant against the focus on GDP and growth, a contemporary theme that readers of my own [amazon_link id=”0691145180″ target=”_blank” ]The Economics of Enough[/amazon_link] will know I believe to be misplaced. Who could disagree with this statement: “If we pursue happiness and happiness alone, we will never be happy. Happiness seems to come as a byproduct of doing something good, not as an end in itself.” (p222) But that is an entirely separate issue from the question about the proper indicators of economic policy and progress.

There are some terrific moments in this book. I like the author’s classification of crises into either the self-fulfilling or the self-averting – and as he points out, we never know which kind we have. I loved his description of money as a form of energy that can travel in time. “Because money is an abstract construct, it is not bounded by matter, space or even time. All you need is a word, possibly written, or even a verbal promise. ‘Start it, I’ll pay.'” (p85).

You have to like a book that quotes [amazon_link id=”B00002695C” target=”_blank” ]Leonard Cohen[/amazon_link] and refers to [amazon_link id=”B00004R80K” target=”_blank” ]The Matrix[/amazon_link]. Its big theme is that economics needs to rediscover poetry and myth. The book reads like the author’s own quest to be a good man although an economist (echoes here of Deirdre McCloskey’s [amazon_link id=”0472067443″ target=”_blank” ]How to be Human Though an Economist[/amazon_link]). Economics is definitely changing, iron grip of mainstream is weakening but I hope we don’t end up throwing out the rigour of conventional economics, which is the danger of this swing of the philosophical pendulum. Sedlacek rightly points out that we teach economics oddly, teaching only the one approach and with no history of thought to put that into context. Economics of Good and Evil was a best seller in the Czech republic almost certainly because there’s a big audience now for the idea that economics, the philosopher king, is wrong. It’s an interesting book, but like many attacks on economics gives no hint of the reality of an exciting scientific renaissance in many areas of the subject, and widespread querying of the old and narrow orthodoxy.

[amazon_image id=”0199767203″ link=”true” target=”_blank” size=”medium” ]Economics of Good and Evil: The Quest for Economic Meaning from Gilgamesh to Wall Street[/amazon_image]

Back from a peaceful two week holiday in the depths of the French countryside – no internet, no mobile signal, walks and swims with a decreasingly grumpy teenage son – I found amidst the weekend newspaper articles analysing the UK riots an interesting Financial Times feature announcing that this is the summer of the e-book. Its author, Carl Wilkinson, sings the praises of e-readers in place of a heavy stack of physical books in the suitcase. The article goes on the describe the flurry of innovation in publishing, a healthy phenomenon that I wrote about here a while ago.

But I do disagree with the FT’s opening premise that e-readers are better for holiday reading. The owners of the house we rented will find I’ve left them a stack of paperbacks finished on holiday, so the weight in the luggage is only one way. And here are all the other reasons physical books, including the paperbacks Mr Wilkinson predicts will be squeezed out of the market by e-readers like the Kindle, are superior.

1. You can’t safely spill sunscreen or wine on an electronic device, or get sand in it, or leave it out in bright sunshine.

2. You can’t share books on a device. I can’t even get e-books I bought on one device onto another device I own, although no doubt one of my domestic IT support staff (sons) could do it for me. I certainly can’t read the e-books my husband downloaded because he’s onto his next e-book on his iPad. E-books torpedo domestic and friendly sharing.

3. They could do the same to the second hand book market (our local Oxfam book shop was damaged in the riots although I fear it was wanton damage rather than self-improving looting; 2nd hand book sales form an important revenue stream for the shops). Nor can you leave your e-books on the book-swap shelf at the local station. No doubt publishers think it’s a good idea to shrink the second hand trade, but they’re wrong: a small number of additional physical sales of new books for them does not remotely compensate for the loss of consumer welfare from a much smaller book market. Besides, as reading is an experience good – consumers have to do it to know how much benefit they get from it – publishers should be thinking of the second hand market as a sort of advertising that drives longer-term sales of their product, especially as students – the most likely long-term readers – have low incomes. Publishers will only thrive if reading thrives!

How big an issue is this? Without having researched the question of second hand sales thoroughly, I did find this report of a now out-of-date US study (via the Booksellers Association):

“Used books are one of the fastest growing segments of the US book industry and the report notes that, propelled by e-commerce, the used book market is ‘exploding’, and it estimates that in 2004 total used-book revenue exceeded $2.2 billion, with 111 million used book units sold, up 11% over 2003. Overall, used book sales are estimated to comprise 8.4% of total consumer spending on books.”

4. You can’t cut and paste quotes from an e-book. Their makers are so paranoid about “intellectual property theft” that to quote from an e-book on this blog, I have to retype the whole thing.

5. How are you supposed to refer others to specific pages of the text – in a footnote for example, or in a review? Floating “locations” have replaced fixed  “pages”. Will authors have to start numbering their paragraphs, as if in a mediaeval manuscript?

6. I particularly hate the Kindle. This is a personal thing, as obviously many eager readers luuuurve the Kindle. What I hate is the smallness of the screen, meaning you only get a couple of hundred words of text on it. I read quickly so have to keep thumbing to the next “page” and get thumb-ache. I hate not having the text immediately preceding the bit I just read. I hate having to keep scrolling back by several “locations” to go back to something rather than just turning back a page. I also hate the greyness of the screen and the ugliness of the device – and correspondingly do love my iPad on which I read work papers and an occasional e-book. I hate the way my e-book has comments and highlights from strangers on it, even if I can turn the feature off.

7. I have other idiosyncratic dislikes of e-books too. For example, I can’t see what other people are reading when I’m on the train. This used to offer moments of delight. One time, sitting in a block of four seats on the Tube, I was reading an improving economics book, and my fellow-passengers were reading a [amazon_link id=”0140293450″ target=”_blank” ]Nick Hornby novel[/amazon_link], Seamus Heaney’s [amazon_link id=”0571230970″ target=”_blank” ]District and Circle[/amazon_link], and [amazon_link id=”0199535663″ target=”_blank” ]Herodotus[/amazon_link]. How cheering is that?

[amazon_image id=”0571230970″ link=”true” target=”_blank” size=”medium” ]District and Circle[/amazon_image]

Enough ranting. Tomorrow, the first of my reviews of my holiday reading.