Part 7 (1/2)
At Milton Friedman's 90th birthday bash, his former student Donald Rumsfeld said that ”Milton is the embodiment of the truth that 'ideas have consequences'”54 The subpriraphic proof that economic myths have consequences These overned byequationsThe myth that individuals or households act independently, and are immune to herd behaviourThe myth that markets are stable, so the future will resemble the pastThe myth that investors or households or firms like Lehman Brothers act rationally, and don't ainst their best interestsThe myth that economics is an objective, impartial mathematical science, rather than a cultural phenomenon that itself influences the economy Finally, there is the myth - discussed further in the next chapter - that free markets are also fair In many ways the subprime story was less about risk than about power Friedman's utopia of a society of maximum individual freedom sounds attractive, until you see how it plays out in the real world Giving coe subpries at teaser rates for financially illiterate people, construct multi-trillion-dollar balloons of credit out of thin air, and then extract oes sour, probably isn't what he had in mind
The crisis, whose consequences are still playing out, is unlikely to be the last demonstration of the power that these ideas still hold Mainstreaovernorean vision of a perfect economy, and therefore fail to learn froate these myths, our universities and business schools sow the seeds for future financial catastrophes Just as faulty risk models make the economy more risky, so a worldview that sees and treats the econo will - by loosening regulations - eventually turn it into the opposite The point is not just that the economy is reflexive, and therefore hard to predict; but that our ideas and myths have shaped the econo in of instability This is perhaps the clearest example of how economic theories influence the world, and therefore lose any pretence at objectivity (As discussed later, this process also works in the other direction: the real econo ideas that suit its power structure) Indeed, it is ironic that, while econoned itself as stereotypically ly connected, changeable, and unpredictable - all traits that are culturally considered stereotypically female55 Economists are the jilted lovers of the science world - the idly they approach their subject, thebehaviour
Mathe and understanding the economy, but they will never be able to accurately predict its course, or fully capture risk To quote author and derivatives trader Pablo Triana: ”Reality is much more ferociously untaely uncageable, aboate it, control it, or decipher it Where anything can happen, there are no mathematically imposed bounds”56 Or as science historian Evelyn Fox Keller puts it: ”Natureis not coht in an essential duality If in soht of reason and order, it is also enmired in the dark forces of unreason and disorder The forces of unreason, in Greek y and drama most often embodied in the earth Goddesses or the Furies, are never fully vanquished, even when they are subdued”57 In its way, the subprime crisis was another manifestation of this eternal archetypal battle between chaos and order; and one in which chaos won
In the 19th century, a band of outsiders sought inspiration fro to create a new theory of econoain
The Great Yinification
Scientists have long dreamed of a Grand Unified Theory that will explain all the known physical forces and the evolution of the universe Some have even hoped for a theory that would unite physics, chey - all the physical and social sciences - in a singleto philosophers Max Horkheis co the which cannot be resolved into numbers, and ultins it to poetry Unity remains the ord from Parmenides to Russell All Gods and qualities must be destroyed”58 As Vilfredo Pareto wrote: ”It is only the imperfections of the humanastronomy from physics or chemistry, the natural sciences from the social sciences In essence, science is one It is none other than the truth”59 What seeh, is a little different Call it the Great Yinification Since the 1960s, as we have seen,developments in applied mathematics have been in areas such as nonlinear dynamics, network theory, and complexity They are about systems that are connected, in flux, and resistant to reductionist logic Rather than providing a single unified theory, these ant proofs, or reductive forli ree of humility is even sometimes present When sceptics say that science can offer little to economics-a view that has become popular since the crisis, as a counter-reaction to the antiquated pseudo-science of mainstream economics - they seem as unaware as neoclassical econo on60 As economists revise their field to reflect these developent-based models discussed in previous chapters, or by a shi+ft from overly abstract and theoretical treate, the field eneity and stereotypical e of talent ”Because models by their nature represent only a partial viewpoint, partiality or bias cannot be elireater opennessis likely to lead to a multiplicity of perspectives that more adequately captures the complexity and diversity of econoht has reshaped areas of study such as literary criticis how econoely bypassed criticism - what could be less politically correct than rational econo field and has been influential in academic areas, discussed in later chapters, such as the study of unpaid work, alternatives to GDP, the role of woical economics However, it has so far had little iender and economic developeh there are so ance and this unwillingness to discuss criticisender much more easily, conventional economics has been one of the most impenetrable disciplines It has been difficult, if not impossible, for orthodox economics to incorporate fe to Beneria, is that ”to deal with gender relations you have to incorporate power into the analysis Neoclassical economics does not deal with power relations; it tends to focus on purely economic issues”
If finance is the ulti econo, cleaning, and caring - which are still do countries These activities aren't just underpaid, they are often not paid at all According to Statistics Canada, such unpaid work is estilobal GDP, yet it doesn't even register as part of the economy63 While the yin economy lacks financial power - it's less of a bonus culture than a tip culture - and isn't often in the news, that doesn't th and influence of a different kind In place of capital, it generates social capital, which sociologists define as the collective value embedded in social networks64 One nice property is that it is less neurotic and fit-prone, andcounterpart People don't give up on caring for each other as easily as they give up on the stockmarket; when there's a real earthquake, nurses don't run out of the hospitals crying ”It's a massive earthquake,” a la Lehman Brothers
Theand productive financial innovations to have eations or credit default swaps, but the range of schemes that provide credit and finance to the world's poor The pioneer in this area was Muhaladesh-based Grameen bank now directs billions of dollars in seted at women because they are more likely to spend it on their faroups” whose uarantors In Kenya, M-Pesa provides a basic banking service, and access to, also known as social lending, does the opposite of CDOs - instead of bundling loans together into an anonye, it uses the internet to match individual lenders with individual borrowers Examples are Zopa in the UK and Kiva Microfunds in the US, which places its loans through e social networks and new technology to provide genuinely useful services to people in need
To build a more balanced and just economy, we first need to rebalance our priorities, and our a but his mind; if that be out of order, all's amiss, and if that be well, the rest is at ease”65 In the next chapter, we consider how thisact of all - that of social inequality
CHAPTER 7
THE UNFAIR ECONOMY
It's not thatpeople do not have aspirations It is that they are blockedSuch elitiser work economically
Alan Milburn MP (2009)
History is a graveyard of aristocracies
Vilfredo Pareto (1916)
Econoht that a well-run market economy is fundamentally fair, so our chance of success depends only on merit The whole point of a competitive market, after all, is that everyone has an equal shot This belief in an underlying equality influences everything froes of CEOs Yet in recent decades, the incoly skeithto the top few per cent of the population When US taxpayers found out about the executive pay packages at government-supported insurer AIG, it nearly led to a populist uprising The inco The reason, as this chapter shows, is that et richer To counter this trend we need a new approach to financial compensation
The physicist Richard Feynreatest of scientific facts was that all things are made of atoms If there is a close second, many scientists would choose the idea that the universe is based on symmetry Just as matter reduces to atoms, so physical laws can be reduced to assertions of symmetry And the discovery of deep syoreans
The ancient Greeks believed that the celestial bodies moved around the earth in perfect circles, because those were the most syers to disparities and disorders” Newton's laws of motion showed that every force creates an equal and opposite force; Maxwell's equations revealed a synetism
The deepest theore that soed These too are based on syy can be neither created nor destroyed in a process, but can only change its form - can be shown to reduce to a statement that the laws of physics are symmetrical in time: if an experiment is done at noon, and then repeated under identical conditions after lunch, the result will be the sa that the laws of physics do not depend on position: if the experimental apparatus is shi+fted a few feet to the side, the result will again be unchanged
Symmetry and reductionis deep symmetries can scientists reduce complex phenomena to simple equations The search for new for role in physics, as can be seen, for example, by the development of the theory known as super-symmetry, which hypothesises that every particle type has a kind of unseen e Many physicists even believe that, when the universe was born, at the , all forces and all forms of matter were one, in a state of perfect symradually broke down in a process called syravity separated fronetism, electrons separated froradually took shape
If physicists seeroupies known as mainstream economists can't be far behind In fact, they take the study of symmetry to a more advanced level Their theories don't assume that the economy was once in a state of symmetry - they assume that it still is This belief is the source of perhaps the greatest economic myth of all - the idea that the economy is inherently fair and balanced
Mirror ie
When econoan to be mathematicised in the late 19th century, economists were forced by the limitations of their mathematical and computational tools to siree of symmetry For example, the assumption of rational behaviour is a kind of syiven the same preferences, would act in exactly the same way When perfectly rational people (if they exist) look at one another, it's like looking in the mirror
The markets were also assumed to be in equilibrium, which is symmetry in time: the past looks exactly like the future And these perfect markets were fair and transparent, so individuals and fires: they all competed on an equal basis and had access to all necessary inforh to affect prices on their own The ”law of supply and dee nu as equals in the same market Statistical methods, based on statistical mechanics, could therefore be applied
While these syinally have been essential for coly resilient over the years Willia in two or more commodities, whose stocks of those co are known to allEvery individual ard to his own requirements or private interests, and there ene Fama defined his efficient e nu, with each trying to predict future market values of individual securities, and where important current information is almost freely available to all participants”2 About the only change, then, was the insertion of the word ”almost”
Econouishi+ng econoents based on power, influence, access to inforender, race, class, or any other characteristic Milton Fried free markets would automatically render such differences irrelevant: ”There is an economic incentive in a free market to separate economic efficiency from other characteristics of an individual A businessman or an entrepreneur who expresses preferences in his business activities that are not related to productive efficiency is at a disadvantage compared to other individuals who do not Such an individual is in effect iher costs upon himself than are other individuals who do not have such preferences Hence, in a freeto theory, sexism, racism or any other form of discrimination is inefficient, so in a pure (ie symmetrical) market it wouldn't exist Econoardless of who is involved or when they take place
Of course, no economist would claim that the real economy is perfectly fair or stable, or that each participant has access to exactly the saes Riksbank Prize in Econoe Akerlof, Michael Spence, and Joseph Stiglitz ”for their analyses of markets with asymmetric information” - in which, for example, sellers of used cars knowsold than the buyers One reason whyis that econo to address what they consider to be isolated flaws in their e phenomena such as ”bounded rationality” or ”asy their core theories, teachings, and ed The truth is that assumptions of symmetry are implicit in theories such as the efficient market hypothesis, and the fascination with simplified, abstract, reductionist models explains what economists M Neil Browne and J Kevin Quinn describe as the ”almost complete absence of power from the toolkit employed by mainstream economists” In a survey they performed of sixteen currently used introductory textbooks - es that dealt with topics directly related to power (and a total of only 25 pages dealing with issues related to woulation is also based on the picture of free and fair competition between equals
As seen with the subpriin to look ridiculous when you cohtly asymmetric, they're totally out of whack Is it really OK to assue holders are co field and have access to the same information? Is Wal-Mart versus the local cornerstore really a fair fight? And does it really make no difference where you are born, who your parents are, what schools you went to, who your friends are, or what your history is?
Circulation of the elites
The French states that ”Any e 20 has no heart Any e 40 has no head”
Following a similar kind of trajectory, perhaps, neoclassical economics started off in an idealistic vein The aim of people like Jevons, Walras, and Pareto was to put econo standards of the general population Jevons was brought up in a Unitarian tradition concerned with social conditions, and spentthe streets of the cities he lived in - Sydney, Manchester, London - observing the conditions of the poor and conte the connections between poverty and economics Walras inherited his socialist ideals fro in the cooperativeup his professorshi+p at Lausanne
As a young man, Vilfredo Pareto was a dedicated deovernment for corruption and corporatisanised by the Italian Socialist Party and resulted in the deaths of hundreds of people, Pareto offered his home in Switzerland to socialist exiles and leftist radicals Even by 1891, though, when Pareto was 43, it appeared that his head was pulling in another direction He wrote to Walras: ”I give up the combat in defense of [liberal] econoet nowhere and lose our time; this time is an to believe that his youthful passion for leftist ideals had been based on eic, and that all human societies were inherently corrupt and irrational
Pareto's cynicism about human motivations was no doubt fuelled in 1901 when he returned home from a trip to find that his wife had run off with the cook and 30 cases of possessions Under Italian law, Pareto couldn't get a divorce He had inherited a large suh to ned his university position and retired to his villa near Lake Geneva, where he lived with a woe stock of the finest wines and liqueurs, and eighteen Angora cats (the house was called Villa Angora)
Pareto continued to blast off incendiary books, articles, and letters, but his ai it froht analyse the social goings-on of an ant hill, but with more spite and irony In his ued that human behaviour is driven by irrational desires, which are then justified by particular ideologies To understand society, one therefore had to focus on the underlying irrational desires, which he classified into six types The most important were innovation (Class I) and conservation (Class II) Everyone was motivated by a mix of these classes, but one could nevertheless speak of ”Class I” types, who are clever and calculating, and ”Class II” types, who are slower, more bureaucratic, and dependent on force
Pareto had earlier discovered the power-law distribution of wealth (the 80-20 rule) in Italy and other countries, and wrote that it ”can be compared in some respects to Kepler's law in astronomy; we still lack a theory that may make this law of distribution rational in the way in which the theory of universal gravitation has made Kepler's law rational”6 Today, ould describe it as an eent property of the econohly-skewed power law as a kind of snapshot that revealed the underlying dynamics of any society
At the top is a s of a ed in a Machiavellian struggle for power There is always a degree of social es as people enter or leave The balance between the two classes therefore varies with time, in a process Pareto called the circulation of the elite If too ent Class I people (Machiavelli's foxes) get in power, then the conservative Class IIs will plot a takeover If the elite is dominated by Class IIs (Machiavelli's lions), then it will become overly bureaucratic and reactive and the Class Is will radual; but, if the circulation becomes blocked, so that ”simultaneously the upper strata are full of decadent elements and the lower strata are full of elite elehly unstable and a violent revolution is iument with nuh, was the coovern over frorown corrupt and ineffectual, and appointed Pareto Senator of the Kingdoed to obtain a divorce andthe same year