Monthly Archives: September 2012

The Crash, Goldman Sachs, J.K.Galbraith and me

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“The crash blighted the fortunes of many hundreds of thousands of Americans. But among people of prominence, worse havoc was worked on reputations. In such circles, credit for wisdom, foresight, and unhappily also for common honesty, underwent a convulsive shrinkage.”

As in the aftermath of 1929, so in the wake of 2008. This was J.K.Galbraith, in [amazon_link id=”014103825X” target=”_blank” ]The Great Crash 1929[/amazon_link]. He goes on to say that Goldman Sachs recovered its reputation relatively quickly, despite having been issuing dodgy investment trust securities at a rate of more than a quarter of a billion dollars less than a month just before the Crash. “It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity,” Galbraith wrote.

It took economists a while longer to rebuild their reputation, he added. “Harvard economics professors ceased forecasting the future and again donned their accustomed garb of humility.” I had the privilege of meeting Professor Galbraith when I was a PhD student at Harvard in the early 1980s, and I must say that ‘humble’ would not be the first adjective to come to mind to describe him. Still, his book on the 1929 Crash is a great read.

[amazon_image id=”0140136096″ link=”true” target=”_blank” size=”medium” ]The Great Crash 1929 (Penguin Business)[/amazon_image]

Simple is difficult

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I’ve been mulling over the question I posed a few days ago, about how to reconcile Andy Haldane’s superb Jackson Hole paper (The Dog and the Frisbee) arguing the case for simpler financial regulation with Cesar Hidalgo‘s equally persuasive arguments for using the capacity of Big Data to give us much more useful detail. It sent me back to one of my all-time favourite economics books, Thomas Schelling’s [amazon_link id=”0393090094″ target=”_blank” ]Micromotives and Macrobehaviour[/amazon_link], which is all about the aggregation of individual decisions. (Coincidentally, Sebastian Mallaby wrote about the same question in the FT yesterday.)

It hasn’t answered my question, but what struck me this time was how difficult it is to come up with the compelling reasons for individuals to align their behaviour in the common interest. There is the traffic light example, but Chapter 3 gives a few examples of effective rules and norms, and many other examples of problems – free-riding, collective action problems, lemons etc. I conclude that simple is difficult – you have to find the right simple rule for the context and it has to create strong self-interest in abiding by it. Still, Schelling is optimistic. He writes:

“These problems often do have solutions. The solutions depend on some kind of social organization, whether that organization is contrived or spontaneous, permanent or ad hoc, voluntary or disciplined….. What we are dealing with is the frequent divergence between what people are individually motivated to do and what they might like to accomplish together.”

And there are many ways to make the collective bargain stick, he argues. I’m in an optimistic mood this morning, and will go with the argument that between social norms, morals, institutions and even regulations can change, and make a big difference to collective outcomes.

[amazon_image id=”0393090094″ link=”true” target=”_blank” size=”medium” ]Micromotives and Macrobehaviour (Fels Lectures on Public Policy Analysis)[/amazon_image]

Marginal intellectuals

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While waiting for my order (thanks to all the great suggestions in comments on this post), I’ve started [amazon_link id=”0231135408″ target=”_blank” ]Taking it Big: C Wright Mills and the Making of Political intellectuals[/amazon_link] by Stanley Aronowitz. The only book I know by C Wright Mills, its subject, is [amazon_link id=”0195133544″ target=”_blank” ]The Power Elite[/amazon_link], which I read off the shelves of my friend and colleague Professor Alan Harding, now setting up a new public policy research center at Liverpool University.

One of the themes of this new study of Mills’ work is his carving out a role for public intellectuals. Aronowitz writes:

“The intellectual in the United States has always occupied an ambiguous position. … they have enjoyed a good measure of freedom of expression – especially the freedom to pay for their independence by remaining relatively poor. However, except for those who work for the state – those who espouse official doctrines or perform policy analysis for those in power – most intellectuals are marginalized or routinely ignored. Intellectuals have never been economically secure, and U.S. society has consistently denied them significant cultural space.”

[amazon_image id=”0231135408″ link=”true” target=”_blank” size=”medium” ]Taking it Big: C. Wright Mills and the Making of Political Intellectuals[/amazon_image]

I’m sceptical about all of this claim. US academics have good salaries, tenure and few external pressures to conform to any particular ideas, although there is obviously internal pressure for disciplinary group think – it happens in any institution. Money certainly speaks in the think tanks and media, but not to the extent of preventing the expression of ideas. But the final point in this comment, about the lack of cultural space for truly independent thinkers, does seem valid. Tony Judt is one of only a few recent examples I can think of to have had an influential voice that cuts through with a wider audience. I’ve not yet read his posthumously published [amazon_link id=”0434017426″ target=”_blank” ]Thinking the Twentieth Century[/amazon_link]. Come to think of it, I must add it to my reading pile.

[amazon_image id=”0434017426″ link=”true” target=”_blank” size=”medium” ]Thinking the Twentieth Century: Intellectuals and Politics in the Twentieth Century[/amazon_image]

What to read?

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I need some recommendations from you. After a summer holiday devouring a pile of books, and with another pile earmarked to send out to reviewers for the winter issue of The Business Economist, I’m a bit short of books in my own in-pile. This is a busy time of year, when all my jobs realise they’ve not had any meetings for six weeks, and decide they need to catch up this week or next at the latest. So there are plenty of papers I could be reading. But where’s the fun in that? I do have a couple of books on my iPad, but regular readers of this blog will know my strong aversion to e-books (and, as if I needed another reason, there’s the e-book legacy issue, although apparently Bruce Willis is not taking Apple to court after all). There are specific requirements too. Of course it must be serious but readable non-fiction, economics and business and their hinterland – history, science, social science. Not too big, so I can carry it around on the Tube (I’m just about to give up on a book so chunk I can only read it in bed propped up on a pillow).

[amazon_image id=”0231135408″ link=”true” target=”_blank” size=”medium” ]Taking it Big: C. Wright Mills and the Making of Political Intellectuals[/amazon_image]

At the moment I only have two choices in the house. They are [amazon_link id=”0231135408″ target=”_blank” ]Taking it Big: C Wright Mills and the Making of Political Intellectuals[/amazon_link] by Stanley Aronowitz and [amazon_link id=”184983296X” target=”_blank” ]Cocktail Hour Under the Tree of Forgetfulness[/amazon_link] by Alexandra Fuller.

[amazon_image id=”184983296X” link=”true” target=”_blank” size=”medium” ]Cocktail Hour Under the Tree of Forgetfulness[/amazon_image]

I think I’ll start with the former. But send me ideas!

Keep it simple, stupid?

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In the past few days I have read two brilliant and fascinating articles, pointing to opposite conclusions. One argues that the extent of complexity in the financial domain is so great that effective regulation can only be achieved by the use of heuristics or rules of thumb. The other argues, equally persuasively, that the potential for ‘big data’ is now so promising that we will not need to map the complexity of the macroeconomy using simple aggregates and averages, but rather will be able to use actual data. My instinct tells me both are correct but I’m still thinking through how they might be reconciled.

The first is a speech given by the Bank of England’s Andrew Haldane at Jackson Hole, The Dog and the Frisbee. He notes that neither humans – nor dogs, who can do it even better – actually solve an optimal control problem when catching a frisbee. They follow the rule of thumb: run at a speed so that the angle of gaze to the frisbee remains roughly constant. Modern finance theory, and consequently financial regulation, has developed models of decision making under risk, but in fact the world features uncertainty and increasing complexity. The strong assumptions about the state of knowledge made in conventional models do not hold.

The speech concludes:

“Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble. As you do not fight fire with fire, you do not fight complexity with complexity. Because complexity generates uncertainty, not risk, it requires a regulatory response grounded in simplicity, not complexity. Delivering that would require an about-turn from the regulatory community from the path followed for the better part of the past 50 years. If a once-in-a-lifetime crisis is not able to deliver that change, it is not clear what will. To ask today’s regulators to save us from tomorrow’s crisis using yesterday’s toolbox is to ask a border collie to catch a frisbee by first applying Newton’s Law of Gravity.”

This seems to me to be obviously true, even if it ruffles feathers in the financial regulatory community.

The second article is a conversation with MIT Media Lab’s Cesar Hidalgo on The Edge, What is Value, What is Money? This covers a lot of territory, but part of it is how we understand complexity in the aggregate. Hidalgo says:

“In the past when we looked at macro scales, at least when it comes to many social phenomena, we aggregated everything. Our idea of macro is, by an accident of history, a synonym of aggregate, a mass in which everything is added up and in which individuality is lost. What data at high spatial resolution, temporal resolution and typological resolution is allowing us to do, is to see the big picture without losing the individuality inside it. I believe that in the future, macro is going to be something that is going to be in high-definition. You’re going to be able to zoom in into these macro pictures and see that neighborhood, and see that person, and understand that individual, and to have more personalized interactions thanks to the data that is becoming available. I think that in some sense, big data can help recover the humanity of a world in which the scientific representations of people have become dehumanized, because of our need to simplify.”

Well, this is an exciting prospect and obviously potentially feasible in the Big Data world. But I’m not yet sure how it sits with the ‘Keep it Simple, Stupid’ moral of the Haldane paper. Or indeed with my strong instinct that public policy interventions are most effective when of the kind described by Thomas Schelling in his brilliant book [amazon_link id=”0393329461″ target=”_blank” ]Micromotives and Macrobehaviour[/amazon_link] – like traffic lights, a clear and simple rule which people have strong incentives to obey.

My dog retraining as a financial regulator