Are economists selfish? Does studying economics make you selfish

Tim Harford in The FT

Against my better judgment, I was recently prevailed upon to play a game of Monopoly with the family. It soon developed in a fashion that has become familiar: everyone tried to rip everyone else’s face off, except me. I proposed a mutually beneficial deal to each player, offering extra concessions myself to make sure those deals got done. This dealmaking tactic didn’t go down well. Every time I reached an agreement with one player, the other players fumed. 

Before long, I was being roundly denounced as a ruthless exploiter of innocents. This made me sad. It was partly the disheartening realisation that I am clearly a punchable opponent at the board-game table. But there was something more. My plight in being cast as a pantomime villain seemed to stand in for the fate of economists as a whole. 

I should explain. In looking for advantageous trades, I was doing what comes naturally to economists. The basic building block of economic activity — so basic that we take it for granted — is two people making each other better off by finding gains from trade. You can easily spot the economists at the Monopoly table, they’re the ones trying to find the deals that make both sides happy. 

But are we lauded for our fascination with voluntary agreements for mutual benefit? We are not. Instead, economists are often accused both of celebrating selfishness and of being selfish. As Yoram Bauman, an economist and comedian, once joked: “The only reason we don’t sell our children is that we think they’ll be worth more later.” 

What have we done to earn this reputation for ruthlessness? Perhaps it’s that altruism and charity are not front and centre in economic analysis. It may be the character of Gordon Gekko in Wall Street (1987), assuring us that “greed, for lack of a better word, is good”, somehow being associated with economists. 

But our reputation for being calculating and unfeeling may also be thanks to the experimental evidence. Over the years, a series of studies have emerged which seem to show that studying economics causes students to behave more selfishly. 

The basic idea sounds plausible. If you sit in enough classes being told that people are fundamentally self-interested, you yourself might become more self-interested. A 1993 paper by Robert Frank, Tom Gilovich and Dennis Regan summarised some of this evidence. It found economics students tended to behave less cooperatively in experimental games. They also expected less honesty from others. For example, if asked whether they would expect a stranger who found some lost cash to try to return it. More recent research by Bauman and his colleague Elaina Rose found that economics students were less likely to contribute to two named charities in a classroom exercise. 

Yet there is a pair of big question marks hanging over this collection of studies. The first is whether economics teaches people to be selfish, or whether instead selfish people gravitate towards economics. Bauman and Rose note that economics majors are equally mean whether they are near the beginning or the end of their studies — in other words, perhaps economics has no effect on people’s generosity, but big-hearted people avoid economics classes. 

Perhaps more important, do these questions really measure honesty, selfishness or any other moral virtue? That’s not clear. In the Bauman and Rose study, for example, the two charities in question were both left-leaning activist groups. So did economics students refuse to contribute because they hate giving to charity? Or did they feel that these particular charities were not very worthy causes? 

As for classroom exercises, there is a sense in which the selfish move is the “correct” answer in certain experimental settings, such as the prisoner’s dilemma game. If a student is taught that, and then plays the selfish move, have they become more selfish in everyday life? It seems just as plausible to suggest that they have been taught how to reproduce the textbook answer in an academic setting and want to pass the economics test. 

There are certain tendencies in mainstream economics that might nudge people towards a cynical view of human nature, but there is also a long tradition in economics arguing that free markets promote co-operation, honesty, respect for others, freedom and reciprocal benefit. 

So does studying economics make you selfish? A new study with that title, by Girardi, Mamunuru, Halliday and Bowles, finds “no discernible effect” of studying economics either on self-interest or on the belief that other people are self-interested. 

I suggest that before besmirching the good character of economics students we should look for more convincing real-world evidence. So far I have found nothing. But my search did turn up the fascinating discovery — courtesy of the philosopher Eric Schwitzgebel — that books about moral philosophy were more likely to be missing from libraries than other philosophy books. A deep academic interest in ethics appears to be correlated with larcenous behaviour. It makes you think. 

Ironically, the game that inspired Monopoly, The Landlord’s Game, was designed by the activist and writer Elizabeth Magie to teach lessons about a fairer taxation system, and then refined by a socialist professor of economics, Scott Nearing, and his students. Yes, the economics nerds were proposing a co-operative, pedagogical version of Monopoly. Alas their vision was eclipsed by the ruthless battle of attrition we all know today. 

Our own session of Monopoly might have been more fun if only my fellow players had embraced the constructive, co-operative spirit of economics. Alas, they did not, so our game finished in the traditional fashion. It petered out with no clear winner and several sore losers.  

Economists had a dreadful 2023

From The Economist 

Spare a thought for economists. Last Christmas they were an unusually pessimistic lot: the growth they expected in America over the next calendar year was the fourth-lowest in 55 years of fourth-quarter surveys. Many expected recession; The Economist added to the prognostications of doom and gloom. This year economists must swap figgy pudding for humble pie, because America has probably grown by an above-trend 3%—about the same as in boomy 2005. Adding to the impression of befuddlement, most analysts were caught out on December 13th by a doveish turn by the Federal Reserve, which sent them scrambling to rewrite their outlooks for the new year.

It is not just forecasters who have had a bad year. Economists who deal in sober empirical work have also had their conclusions challenged. Consider research on inequality. Perhaps the most famous economic studies of the past 20 years have been those by Thomas Piketty and his co-authors, who have found a rising gap between rich and poor. But in November a paper finding that after taxes and transfers American incomes are barely less equal than in the 1960s was accepted for publication by one of the discipline’s top journals. Now Mr Piketty’s faction is on the defensive, accusing its critics of “inequality denial”.

Economists have long agreed that America would be richer if it allowed more homes to be built around popular cities. There is lots of evidence to that effect. But the best-known estimate of the costs of restricting construction has been called into question. Chang-Tai Hsieh of the University of Chicago and Enrico Moretti of the University of California, Berkeley, found that easing building rules in New York, San Francisco and San Jose would have boosted American gdp in 2009 by 3.7%. Now Brian Greaney of the University of Washington claims that after correcting for mistakes the true estimated effect is just 0.02%. If builders disagreed as wildly about roof measurements, the house would collapse.

Think social mobility in America is lower than it was in the freewheeling 19th century, when young men could go West? Think again, according to research by Zachary Ward of Baylor University. He has updated estimates of intergenerational mobility between 1850 and 1940 to account for the fact that past studies tended to look only at white people, as well as correcting other measurement errors. It now looks as if there is more equality of opportunity today than in the past (albeit only because the past was worse than was thought).

A rise in suicides, overdoses and liver disease has reduced life expectancy for white Americans. Angus Deaton and Anne Case of Princeton University popularised the idea that these are “deaths of despair”, rooted in grimmer life prospects for those without college degrees. But economists have been losing faith in the idea that overdoses, which are probably the biggest killer of Americans aged 18-49, have much to do with changes in the labour market. New research has instead blamed the carnage on simple proximity to smuggled fentanyl, a powerful opioid.

Other findings are also looking shaky. The long decline in the prestige of the once-faddish field of behavioural economics, which studies irrationality, continued in 2023. In June Harvard Business School said it believed, after an investigation, that some of the results in four papers co-written by Francesca Gino, a behavioural scientist and phd economist, were “invalid”, owing to “alterations of the data”. (Ms Gino, who has written a book about why it pays to break rules, is suing for defamation the university and the bloggers who exposed the alleged fiddling.)

What lessons should be drawn from economists’ tumultuous year? One is that for all their intellectual discipline they are still human. Replicating existing studies and checking them for errors is crucial work.

Another lesson is that disdain for economic theory in favour of the supposed realism of empirical studies may have gone too far. After the global financial crisis of 2007-09, commentators heaped opprobrium on theorists’ common assumption that people make rational predictions about the world; gibes about an unrealistic, utility-maximising Homo economicus helped raise the status of behavioural economics. Yet rational-expectations models allow for the possibility that inflation can fall rapidly without a recession—exactly the scenario that caught out forecasters in 2023.

A last lesson is that economists should cheer up. The research that has been called into question this year inspired much pessimism about the state of modern capitalism. But a dodged recession, flatter inequality trends and less despair would all be good news. Perhaps the dismal science should be a little less so. ■

Is Raghuram Rajan wrong about his economic forecasts for India?

 

Economists Stole our Money, Gave it to the Rich

 

Welcome to the era of the bossy state

The relationship between governments and businesses is always changing. After 1945, many countries sought to rebuild society using firms that were state-owned and -managed. By the 1980s, faced with sclerosis in the West, the state retreated to become an umpire overseeing the rules for private firms to compete in a global market—a lesson learned, in a fashion, by the communist bloc. Now a new and turbulent phase is under way, as citizens demand action on problems, from social justice to the climate. In response, governments are directing firms to make society safer and fairer, but without controlling their shares or their boards. Instead of being the owner or umpire, the state has become the backseat driver. This bossy business interventionism is well-intentioned. But, ultimately, it is a mistake.
 
Signs of this approach are everywhere, as our special report explains. President Joe Biden is pursuing an agenda of soft protectionism, industrial subsidies and righteous regulation, aimed at making the home of free markets safe for the middle classes. In China Xi Jinping’s “Common Prosperity” crackdown is designed to curb the excesses of its freewheeling boom, and create a business scene that is more self-sufficient, tame and obedient. The European Union is drifting away from free markets to embrace industrial policy and “strategic autonomy”. As the biggest economies pivot, so do medium-sized ones such as Britain, India and Mexico. Crucially, in most democracies, the lure of intervention is bipartisan. Few politicians fancy fighting an election on a platform of open borders and free markets.

That is because many citizens fear that markets and their umpires are not up to the job. The financial crisis and slow recovery amplified anger about inequality. Other concerns are more recent. The world’s ten biggest tech companies are over twice as big as they were five years ago and sometimes seem to behave as if they are above the law. The geopolitical backdrop is a far cry from the 1990s, when the expansion of trade and democracy promised to go hand in hand, and from the cold war when the West and the Soviet Union had few business links. Now the West and totalitarian China are rivals but economically intertwined. Gummed-up supply chains are causing inflation, reinforcing the perception that globalisation is overextended. And climate change is an ever more pressing threat.

Governments are redesigning global capitalism to deal with these fears. But few politicians or voters want to go back to full-scale nationalisation. Not even Mr Xi is keen to reconstruct an empire of iron and steel plants run by chain-smoking commissars, while Mr Biden, despite his nostalgia for the 1960s, need only walk through America’s clogged West Coast ports to recall that public ownership can be shambolic. At the same time the pandemic has seen governments experiment with new policies that were unimaginable in December 2019, from perhaps $5trn or more of handouts and guarantees for firms to indicative guidance on optimal spacing of customers in shopping aisles.

This opening of the interventionist mind is coalescing around policies that fall short of ownership. One set of measures claims to enhance security, broadly defined. The class of industries in which government direction is legitimate on security grounds has expanded beyond defence to include energy and technology. In these areas governments are acting as de facto central planners, with research and development (r&d) spending to foster indigenous innovation and subsidies to redirect capital spending. In semiconductors America has proposed a $52bn subsidy scheme, one reason why Intel’s investment is forecast to double compared with five years ago. China is seeking self-sufficiency in semiconductors and Europe in batteries.

The definition of what is seen as strategic may well expand further to include vaccines, medical ingredients and minerals, for example. In the name of security, most big countries have tightened rules that screen incoming foreign investment. America’s mesh of punitive sanctions and technology export controls encompasses thousands of foreign individuals and firms.

The other set of measures aims to enhance stakeholderism. Shareholders and consumers no longer have uncontested primacy in the hierarchy of groups that firms serve. Managers must weigh the welfare of other constituents more heavily, including staff, suppliers and even competitors. The most visible part of this is voluntary, in the form of “esg” investing codes that score firms for, say, protecting biodiversity, local people or their own workers. But these wider obligations may become harder for firms to avoid. In China Alibaba has pledged a $15bn “donation” to the Common Prosperity cause. In the West stakeholderism may be enforced through the bureaucracy. Central banks and public pension funds may shun the securities of firms judged to be anti-social. America’s antitrust agency, which once safeguarded consumers alone, is mulling other aims such as helping small firms.

The ambition to confront economic and social problems is admirable. And so far, outside China at least, bossier government has not hurt business confidence. America’s main stockmarket index is over 40% higher than it was before the pandemic, while capital spending by the world’s largest 500-odd listed firms is up by 11%. Yet, in the longer term, three dangers loom.
High stakes

The first is that the state and business, faced by conflicting aims, will fail to find the best trade-offs. A fossil-fuel firm obliged to preserve good labour relations and jobs may be reluctant to shrink, hurting the climate. An antitrust policy that helps hundreds of thousands of small suppliers will hurt tens of millions of consumers who will end up paying higher prices. Boycotting China for its human-rights abuses might deprive the West of cheap supplies of solar technologies. Businesses and regulators focused on a single sector are often ill-equipped to cope with these dilemmas, and lack the democratic legitimacy to do so.

Diminished efficiency and innovation is the second danger. Duplicating global supply chains is extraordinarily expensive: multinational firms have $41trn of cross-border investments. More pernicious in the long run is a weakening of competition. Firms that gorge on subsidies become flabby, whereas those that are protected from foreign competition are more likely to treat customers shabbily. If you want to rein in Facebook, the most credible challenger is TikTok, from China. An economy in which politicians and big business manage the flow of subsidies according to orthodox thinking is not one in which entrepreneurs flourish.

The last problem is cronyism, which ends up contaminating business and politics alike. Firms seek advantage by attempting to manipulate government: already in America the boundary is blurred, with more corporate meddling in the electoral process. Meanwhile politicians and officials end up favouring particular firms, having sunk money and their hopes into them. The urge to intervene to soften every shock is habit-forming. In the past six weeks Britain, Germany and India have spent $7bn propping up two energy firms and a telecoms operator whose problems have nothing to do with the pandemic.

This newspaper believes that the state should intervene to make markets work better, through, for example, carbon taxes to shift capital towards climate-friendly technologies; r&d to fund science that firms will not; and a benefits system that protects workers and the poor. But the new style of bossy government goes far beyond this. Its adherents hope for prosperity, fairness and security. They are more likely to end up with inefficiency, vested interests and insularity.

Farmers, Economists & Indian Democracy

 

What's wrong with mainstream economics? Prof. Richard Werner

 

Covid is forcing economists to look at other disciplines for recovery clues

Larry Elliot in The Guardian

Three times a week an update on new Covid-19 cases is published by the economics consultancy Pantheon. Vaccination rates are monitored by the Swiss bank UBS. The scientists advising the government are in regular contact with the Bank of England’s monetary policy committee – the body that sets interest rates.

Richard Nixon may or may not have said “we are all Keynesians now” after the US broke its link with gold in 1971 but one thing is for sure: all economists are epidemiologists now. And there’s a downside and an upside to that.

The downside is that economic forecasting is currently even more of a mug’s game than usual because even the real (as opposed to the amateur) epidemiologists don’t really know what is going to happen next. Are there going to be new mutations of the virus? Assuming there are, will they be less susceptible to vaccines? Will Covid-19 go away in the summer only to return again as the days get shorter, as happened last year? Nobody really knows the answers to those questions.

The upside is that the pandemic has forced economists to look beyond their mechanical models and embrace thinking from other disciplines, of which epidemiology is just one.

For a start, it is hard to estimate how people are going to react to the easing of lockdown restrictions without some help from psychologists. It is possible that there will be an explosion of spending as consumers, in the words of Andrew Bailey, “go for it”, but it is also possible that the second wave of infection will make them a lot more cautious than they were last summer, when there was still hope that Covid-19 was a fleeting phenomenon.

An individual’s behaviour is also not entirely driven by their own economic circumstances. It can be strongly affected by what others are doing. If your peer group decides after having the vaccine that it is safe to go to the pub, that will probably affect your decision about whether to join your mates for a drink, even if you are slightly nervous. Sociology has a part to play in economic forecasting.

As does history, if only to a limited extent, because there are not a lot of comparable episodes to draw upon. A century has passed since the last truly global pandemic and there is only so much that can be learned from the outbreak of Spanish flu after the first world war. But when Andy Haldane, the chief economist of the Bank of England, says the economy is like a coiled spring waiting to be unleashed, that’s because he thinks there are lessons to be learned from the rapid recovery seen last summer. Back then, the economy followed a near 19% collapse in the second quarter of 2020 with a 16% jump in the third quarter.

Naturally, economics has a part to play in judging what happens next. Millions of people (mostly the better off) have remained in work on full pay for the past year but have struggled to find anything to spend their money on. Millions of others – those furloughed on 80% of their normal wages or self-employed people who have slipped through the Treasury’s safety net – are less well-off than they were a year ago and may fear for their job prospects.

In an ideal world, the better-off would decide that the amount of money saved during lockdown was far in excess of what they needed and would then go on a spending spree: heading out for meals, taking weekend breaks, buying new cars; having their homes re-decorated. That would provide jobs and incomes for those on lower incomes.

But it might not work out like that. If the better-off leave their accumulated savings (or most of them, at least) in the bank, that means higher unemployment for those working in consumer-facing services jobs – such as hotels and restaurants – and an economy with a dose of long Covid.

There are two conclusions to be drawn from all of this. The first is that precise forecasts of what is going to happen to the economy over the next year, or even the next few months, should be treated with caution. Assuming the vaccination programme continues to go well, assuming that there are no further waves of infection, assuming restrictions are lifted steadily from early March onwards, and assuming that people come out of hibernation rapidly and in numbers, then the economy will start to recover in the second quarter. But there are a heck of a lot of assumptions in there: it might take until the third quarter for the bounce back to begin; the recovery might prove weaker or stronger than the consensus currently expects.

The second conclusion is equally obvious. If, as is clearly the case, the existence of so many imponderables makes precision forecasting more difficult than normal, it makes sense for economic policy makers to act with caution. For the Bank of England, that means no dash to embrace negative interest rates, which won’t be necessary if Haldane’s bullishness proves to be justified; and for the Treasury it means extending financial support and ignoring calls for higher taxes, especially those that might lead businesses to collapse or cut back on investment.

It would appear that Rishi Sunak has reached the same conclusion. There has been far less talk from the chancellor recently about the need to reduce the UK’s budget deficit, a process that has now been delayed until the second budget of 2021 in the autumn. By that stage, it might well once again by Sunak rather than the epidemiologists running the economy. Well, perhaps.

Economics for Non Economists 5 – Inflation - Why is the government’s inflation rate lower than my personal experience?

By Girish Menon

Some of you would have realised that in the China virus season the supermarkets have raised prices and stopped offering discounts on many goods. As a result you would have experienced rising food bills which according to layman knowledge should translate into inflation*. At the same time, you may have read many economists predict a period of recession, deflation** and high levels of unemployment. So how is it that when you are experiencing inflation personally, economists predict the existence of deflation?

It all depends on the way the inflation rate is calculated.

The UK government uses the Consumer Price Index (CPI) to estimate the inflation rate in the British economy. It works like this:

1. Every year a few thousand families are asked to record their expenditure for a month. From this data the indexers estimate the types of goods and services bought by an average household and the quantity of their income spent on these goods.

2. With this information, surveyors are sent out each month to record prices for the above mix of goods. Prices are recorded in different areas of the country as well as in different types of retail outlets. These results are averaged out to find the average price of goods and this is converted into index numbers.

3. Changes in the price of some goods are considered more important than others based on the proportion of the income spent by the average household. This means that the above numbers have to be weighted before the final index is calculated. 

---Topics covered earlier

Relation between Debt and Profit

Explaining GDP and Economic Growth

Quantitative Easing

What is a Free Market

---

Consider this example:

Assume that there are only two goods in the economy, food and cars. The average household spends 75% of their income on food and 25 % on cars. Suppose there is an increase in the price of food by 8% and of cars by 4% annually.

In a normal average calculation, the 8% and 4% would be added together and divided by 2 to arrive at an average inflation of 6%

However, this provides an inaccurate figure because spending on food is more important in the household than spending on cars. Food is given a weight of 75% and cars are given a weight of 25%. So the price increase of food is multiplied by ¾ (8*3/4 = 6) and added to the price increase of cars which is multiplied by ¼ (4*1/4 =1) which will result in an inflation of 7%.

Therefore if the inflation index was 100 at the start of the year then it will read 107 at the end of the year.

The accuracy of inflation calculations

As the example makes clear this calculation is based on an imagined average family’s spending patterns. There maybe only a few families in the UK that have the exact same spending patterns as imagined by the government.

Theoretically, different rates of inflation could be calculated within an economy by changing the consumption patterns or weightings in the index. This will explain why the inflation that you experience may be higher or lower than the government’s inflation rate.

* Inflation is an average increase in price level compared over a previous period.

** Deflation is an average decrease in price level compared over a previous period.

Disinflation means the inflation in the current period is lower than the earlier period.

Economics for Non Economists 4 - The Marriage of Debt and Profit in Capitalism

 by Girish Menon (Adapted from: Talking to my Daughter about the Economy by Yanis Varoufakis)

How does a new entrepreneur start?

 Let’s call her Indira. Indira will need some money (capital) to hire the factors of production i.e. to pay wages, for raw materials, machines and for rent to start her business. Since she will only get money after she has sold her goods, she has to take a loan to get started and the loan taken to get started is called Debt.

 Also, since the amount of wages, raw materials and rent are decided in advance the only person who does not know what she will end up with at the end of the process is Indira the entrepreneur. Hence achieving a profit becomes the most important goal for Indira in order to survive and not to end up with unpayable debt.

---For earlier articles

Explaining GDP and Economic Growth

Quantitative Easing

What is a Free Market

---

 Entrepreneurs as time travellers

 When Indira takes a loan to get started, what is she actually doing? In the format of a sci-fi movie, she is looking into the future through a semi-transparent membrane. Sensing an opportunity, she then pushes her hand into the future and grabs the revenue she will make and pulls her hand back into the present.

 If Indira has discerned the future accurately, then she will be successful and will earn enough to repay the loans that she borrowed to start with. However, if she has predicted the future wrongly then her business will fail and she will be unable to repay her loan and become bankrupt.

 Bankers as time travel agents

 Nowadays bankers create money out of thin air. Yes, they have the power to type the numbers in your bank account and money is created. Since bankers have very few constraints on the amount of money they can conjure, they have great incentive to lend money and earn interest and other fees. After all the more money they create and lend in an economy the greater the profits for themselves.

 Bankers - Heads I win and tails you lose

 Earlier, bankers would lend to entrepreneurs like Indira if they trusted her to able to repay her loan in the future. But nowadays banks have found a way to insulate themselves from Indira’s failure. For example, once a bank has given a loan of say £400,000, then the bank would chop up this loan into little pieces and sell it on to others i.e. in return for lending the bank £100 each; four thousand investors would each be given a share in the £400,000 loan. Thus the bank has already recovered the loan and will make a profit when Indira repays her loan. If Indira goes bankrupt then the four thousand investors will lose their money.

Positive Multiplier

 Suppose Indira is successful, she will hire workers, buy raw materials… these factor suppliers will receive wages and rents and buy more goods and the process of recycling goes on a positive and upward scale increasing GDP, more employment, more new businesses etc.

 The Crash

As the economy grows, banks will lend even larger amounts of loans until it reaches a point when the loans they have made are so vast that the economy cannot keep pace. At this point realization dawns that the large loans will not be repaid and the economy crashes.

 Due to the bank’s enthusiastic lending the once successful Indira may now find it difficult to repay her loan. She will now have to close down her business and the workers and suppliers will no longer get wages or rents. This may affect other businesses and a downward spiral starts resulting in bankruptcies, lower GDP, unemployment….

Debt, Profits and Crashes

Thus debt is indispensable in capitalism. There can be no profit without debt. However, the very same process that generates profits and wealth also generates financial crashes and economic crises.

Economics for Non Economists 2 – Quantitative Easing Explained

by Girish Menon

Pradhip, you have asked for an ‘Idiot’s guide on Quantitative Easing and how it affects the economy’. Let me try:

The Bank of England (BOE) has been practising Quantitative Easing (QE) since 2009. The amounts are:

Time	Amount in £ Billions
Nov. 2009	200
July 2012	375
Aug. 2016	435
Mar. 2020	645
June 2020	745

Ref – The Bank of England

What exactly did the BOE do when they said they were doing QE?

The BOE created additional digital money and used it to buy financial assets (especially government bonds) which were owned by the privately owned banks, pension funds and others.

How did they create this additional money?

Unlike you or me who would be arrested if we did this; the BOE has been conferred with monopoly powers to conjure up any amount of money from thin air by typing the necessary numbers into its bank accounts. It’s as simple as saying, ‘Let there be £745 billion and it appears in the bank’s accounts.

Why do they do QE?

Post the 2008 financial crisis there was a liquidity crisis (see below for explanation of liquidity crisis). The BOE by buying the government bonds from local banks transferred cash to them thus enabling them to start their lending activities in the economy.

In 2020 too they have done the same, but this time I suspect that even if the commercial banks are willing to lend there may not be enough borrowers and so this policy may not have the intended effect of stimulating economic growth.

How does QE affect the economy?

The dominant worldview is that debt drives the world. So QE ensures that lenders have enough money to lend to prospective borrowers. Borrowers borrow money to produce and sell goods at a profit; enabling them to repay their loans with interest while creating jobs in the economy.

The above borrower will use his loan to buy machinery, employ labour…. One man’s spending is another man’s income, so the money begins to circulate among citizens in an economy and a positive spiral will push economic growth and create employment.

However, all this theory hinges on the citizens’ confidence about the future. In the current Covid climate, with firms downsizing at will and people worried about their future, I doubt if there will be a critical mass of borrowers to re-start the stalled economic activity.

Pradhip, thus the BOE does indeed have a magic wand to create money out of thin air. You may ask why is it that in a free market I am not allowed to create my own money? Now that question will be considered seditious!

----

 

What Is a Liquidity Crisis?

A liquidity crisis is a financial situation characterized by a lack of cash or easily-convertible-to-cash assets on hand across many businesses or financial institutions simultaneously. In a liquidity crisis, liquidity problems at individual institutions lead to an acute increase in demand and decrease in supply of liquidity, and the resulting lack of available liquidity can lead to widespread defaults and even bankruptcies. (Ref Investopedia)

---Also watch

Economics for Non Economists 1: What is a free market economy?

by Girish Menon

Suma, you have asked a really fundamental question and I will try to answer it in two parts viz;

-         What is a market economy?

And

-         What does free mean in the context of free market economy?

So let’s start with the first aspect – What is a market economy?

The activity of buying or selling a good is called a market transaction or a market activity. Thus a market is a set of arrangements where goods are exchanged for money.

Today most countries in the world adopt the market model for the production and consumption of goods and services. They believe in the Adam Smith quote, ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.’

Google Dictionary defines self interest (own interest) as ‘one's personal interest or advantage, especially when pursued without regard for others.’ Some economics texts assume that the self interest of a goods producer is to earn profits whereas the self interest of a consumer is to maximise her happiness by paying for goods she requires.

Adam Smith’s theory expects citizens in an economy to be both producers and consumers of goods. As a producer you are expected to generate a profit from your toils. You, as a consumer, are expected to use the profits to buy other goods to live your life.

Based on the above logic, market theory predicts that if all the citizens of an economy are left to pursue their self interest then it will result in the automatic production of all goods and services that citizens require in order to be happy.

Though Adam Smith preferred the word ‘invisible hand’, I have used the term automatic. Google dictionary defines automatic as ‘working by itself with little or no direct human control’. In other words producers make and sell goods which they think will be demanded and hope to profit from it. There is no authority other than their anticipation of consumer needs that guide their decision to produce and sell goods. Similarly, consumers pay for a good because they think it will make them happier and there is nobody telling them what to buy and consume.

Thus, a market economy would be an economy where the production and consumption of all/most goods and services is determined by the self interest of its producers and consumers. This system is also known as capitalism.

 ----

So, what is a free market economy?

These days it’s not only the UK, USA etc. but many other countries who call themselves free market economies. But are they truly free market economies where the production and consumption of all goods are determined automatically with its citizens unabashedly following their self interest?

I notice that you seem to be shaking your head. Especially in this Covid climate you will have noticed the role that the UK government has played in your life and the way it has affected your pursuit of self interest and happiness. So what I will now do is list the conditions necessary for Adam Smith’s theory of the invisible hand to work:

1. There are many buyers for a good in the market and no buyer is large enough to get a discount on the price.
2. There are many small sellers of a good in the market and no seller is large enough to set its own price.
3. The goods produced and consumed are identical or homogeneous. In other words a consumer cannot recognise the producer of the good.
4. There must be freedom of entry to the market – or no barriers that prevent a potential producer from entering the market.
5. There must be freedom of exit from a market – if a producer wishes to quit a market then s/he should be able to do so freely and without any sunk costs.
6. There must be perfect knowledge. Producers must have full knowledge of the technologies used by its rivals and consumer preferences. Consumers must be aware of the short and long term benefits and costs from consuming a good.
7. The factors of production must be mobile. It means that the land, workers, machines used for producing a good should be easily redeployed to producing any other good when demand changes,
8. There must be no transport costs.
9. There must be independence in decision making. No external forces affect the decision making ability of producers and sellers.
10. No externalities. The act of production and consumption based on self interest should not result in benefits or costs to third parties.

I am sure that after you have read the above conditions you will agree that neither the UK economy nor for that matter the Indian economy is anywhere close to being a free market economy. I don't think there is a single economy in the whole world that satisfies most of the conditions of a free market.

I will now let Ha Joon Chang have the final word on free markets:

“The free market (economy) does not exist. Every market has some rules and boundaries (by governments) that restrict freedom of choice. A market looks free only because we so unconditionally accept its underlying restrictions that we fail to see them. How ‘free’ a market is cannot be objectively defined. It is a political definition. The usual claim by free market economists that they are trying to defend the market from politically motivated interference by the government is false. Government is always involved and those free-marketeers are as politically motivated as anyone. Overcoming the myth that there is such a thing as an objectively defined ‘free market’ is the first step towards understanding capitalism.’

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• When I presented this article to Suma she said, 'Girish, you have not understood my question. I meant where can I find the free goods that should by definition be there in a free market?' 

Why well-to-do Indians are fleeing the country and economists aren’t returning

The economic refugees of old have been replaced by well-placed people leaving (or staying away from) India’s unattractive political economy writes TN NINAN in The Print

Montek Singh Ahluwalia, in his non-memoir, Backstage: The Story behind India’s High Growth Years, recounts how he and wife, Isher, decided to return to India from Washington 40 years ago, giving up attractive careers at the World Bank and International Monetary Fund (IMF). Montek joined government as an economic adviser in the finance ministry, and Isher joined a think tank. They would have had modest salaries and below-par government housing, but they felt they were contributing to India’s development process. Along the way, they became the capital’s power couple, so life had its compensations.

Other economists too came back around the same time, some earlier, and some later: Manmohan Singh, Bimal Jalan, Vijay Kelkar, Shankar Acharya, Rakesh Mohan, and so on. They returned after studying at the best universities and working in plum jobs at international organisations. They and others like them became the leading makers (or influencers) of economic policy for the next three or four decades, rising like Montek to high offices and enjoying good reputations, plus of course the bungalows of Lutyens’ Delhi and social cachets that would not be available to them elsewhere.

The question that was posed earlier this week at the release of Montek’s book was: Why aren’t people like them coming back today, bag and baggage, to set down roots here in India? The ones who came more recently were clutching the green cards that gave them an escape hatch through which to return to green pastures: Arvind Panagariya, Raghuram Rajan, Arvind Subramanian, and other perfectly honourable gentlemen like them.

One answer is that India has always had economic refugees, and they went where they could find jobs (in West Asia and Singapore), or a better education that would underwrite good careers. Many have done brilliantly, heading global tech giants and winning Nobel prizes. But there is a darker side to the story. Although India is no longer the desperately poor country of the 1980s and 1990s (having risen a few years ago to lower-middle income status), has ceased to be an economic prison like Cuba, and offers more career options with higher salaries, vastly superior cars and consumer goods, modern hospitals, and new liberal arts colleges, and the simple freedom to travel without signing “P” forms and getting eight dollars to take with you, it seems to have become a less attractive country in which to live and work.

Businessmen, including some with recognisable names and faces, are becoming “overseas citizens”. They are investing more in other markets where life is simpler. Wealthy professionals with internationally marketable skills and degrees are also taking their money with them (prompting the finance minister in her Budget to introduce a tax on such money transfers). They may be fleeing tax terrorism, prodded by more limited economic opportunities than they had imagined, or simply keeping one foot in India and another overseas because public discourse here has acquired a nasty edge and who knows what’s coming next. Or perhaps it is just the air quality in our cities which is a deterrent. Whatever the reason, the economic refugees of old have been replaced by well-placed people leaving (or staying away from) India’s unattractive political economy. Diplomats from under-populated countries like Australia and Canada report a sudden increase in the number of Indians seeking to emigrate.

The other question is, should our economists look back with satisfaction, or in anger? To be sure, there were high points like the reforms of 1991, the years of rapid growth a decade ago, and transformation in sectors like telecom. But we should not have waited till 1991 to launch the reforms. As Montek writes, Rajiv Gandhi was warned by the IMF chief in early 1988 that a crisis was building up, but he did nothing. The telecom revolution here was not special to India; other countries too engineered dramatic improvements in tele-density. Nor were India’s years of rapid growth unique; emerging markets as a whole grew at 7.9 per cent in 2004-08. Forget China, today India is being bettered in trade by Bangladesh and Vietnam. And the Thai baht is worth Rs 2.25; it was half that in 1991.

On Economists, Politics and Experts

Economists have started to take morality seriously

Ben Chu in The Independent

“We don’t do God,” Tony Blair’s press secretary, Alistair Campbell, once famously remarked. Similarly, economists don’t “do” morality.

They are a breed concerned with economic efficiency not spiritual uplift; human choices and incentives, not human values. They believe questions of morality can be left to philosophers and theologians.

There’s an element of truth in that stereotype. Economists have indeed tended to leave aside issues of morality. In some cases that’s because they think, on ideological grounds, that it has no place in the discipline.

But even more thoughtful and less dogmatic economists have tended to shy away from the question on the grounds that moral values are tricky to pin down, much less quantify.

That’s not to say that their research agendas have not supported “moral” agendas. They often expose market failures which harm the less well-off. And they defend the right of governments to intervene in markets in ways that might reduce short-term economic efficiency, such as by fining polluters.

They argue for the responsibility of governments to provide public goods like education. And there are also plenty of mainstream economists who justify progressive taxation on the grounds that high inequality is socially undesirable.

Yet their theoretical models themselves have generally had no place for morality.

But things might be changing. Two economic Nobel laureates at a meeting on the German island of Lindau last week outlined a bold attempt to put morality into theoretical economical modelling.

Oliver Hart, a 2016 Nobel winner, presented a paper, co-authored with Luigi Zingales, in which he looked at how the personal morality of shareholders might affect the behaviour of the companies in which they invest, in particular whether those firms will behave in a way that will maximise profits or whether they sacrifice some profit for the sake of behaving in a socially responsible manner.

To give an example, it’s perfectly legal for the American supermarket giant Wal-Mart to sell automatic weapons. But its executives could, in theory, choose not to do so. So what determines the corporate decision?

The Hart model raises the possibility that the incentives in the system of stock-market listed companies – the psychology of shareholders and the pressures on managements – might be behind an “amoral drift” in corporate behaviour.

In a similar vein, Jean Tirole, who won the Nobel in 2014, outlined at Lindau a theoretical framework in which he, along with Armin Falk, tries to model behaviour taking into account how certain popular “narratives” can inhibit people from doing what they would normally consider the right thing. A good example of such a narrative in the British context might be popular opposition to the admittance of Syrian child refugees on the false belief, pushed hard by the right-wing media, that they are all really adults pretending to be children.

“Economics is fundamentally a moral and philosophical science, embedded in the larger social sciences,” Mr Tirole said, urging other economists in the audience to join in the project of trying radical new approaches.

It remains to be seen whether this particular research agenda gets anywhere. There are plenty of holes that one can pick in the very simple models presented by Hart and Tirole and the broad-brush assumptions they make about people’s decision-making processes – something they both readily acknowledged.

It may turn out that the particular value that economics adds does indeed lie more in analysing the behaviour of broadly self-interested individuals in markets (whether competitive or not) rather than trying to build models that factor in more complex human motivations.

Yet those who criticise the “dismal science” for assuming that we are all self-interested robots should at least acknowledge these efforts by some of the luminaries of the field.

And this work is also a useful rebuke to the charge that by analysing human behaviour as narrowly self-interested the economics profession is implicitly encouraging people to behave in that selfish way, that the axioms of classical economics have a “normative” impact on society. 

And in a sense this is a return to older ways of thinking. Seventeen years before he wrote The Wealth of Nations in 1776 Adam Smith produced The Theory of Moral Sentiments.

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortunes of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it,” wrote the revered father of economics.

Some of Adam Smith’s successors, at least, are taking those insights seriously.

The economists have had another terrible year. It's time for a complete re-think

Jeremy Warner in The Telegraph


This may or may not be a good time for democracy, but one thing is certain about the past year of political upsets; it’s heaped further humiliations on the economics profession.

A substantial majority of economists thought the mere act of voting for Brexit would pole-axe the economy. Not only did voters ignore these warnings, but so far the “experts” have proved almost wholly wrong.
Internationally, the story is much the same. The profound shock to global confidence anticipated by the International Monetary Fund, the OECD , Uncle Tom Cobley and all, failed to materialise; Brexit had no discernible impact on the world economy. Having cried wolf over the short term consequences, the profession should not be surprised if rather more credible warnings of pain delayed are widely disbelieved.

Similarly with Donald Trump, where the widely expected economic and market mayhem his election would supposedly unleash has so far been conspicuously absent. This collective misreading has been widely attributed to the perils of “groupthink” – where opinion hugs the consensus for fear of derision - or more conspiratorially, to vested interest and deliberately misleading intent.

But there is in fact a more prosaic explanation; that as a discipline, the dismal science has quite simply lost the plot. All over the shop, economics seems incapable of answering the great questions of our time. Are we heading for deflation or inflation? Are we locked in secular stagnation or have we finally put the financial crisis behind us?

The conceit of modern economics is that it sees itself as an evidence-based science, yet if it could ever be such a thing, it is today no nearer its goal than when Adam Smith penned the Wealth of Nations, and in some respects, a good deal less so.

In a devastating recent analysis, the American economist Paul Romer asserted that macro-economics has been going backwards for more than three decades, with economic modelling succumbing to what he has called “mathiness”, an obsession with mathematic laws and equations which bear very little relation to the real world, ignore the lessons of other disciplines and are frequently out of touch with the inherently unpredictable nature of human behaviour.

When he wrote his treatise, Adam Smith was not an economist at all, but a professor of moral philosophy, yet many economists have come to believe that they should be as divorced from moral judgement as scientists – that economics should be a technical discipline free of ethical concerns. In the battle between moralism and mechanism, mechanism won. Unlike science, however, it doesn’t appear to have delivered anything remotely useful.

Few of the profession’s more recent failings should have come as any great surprise, for they merely follow the monumental breakdown in economic analysis exposed by the financial crisis. The Queen’s faux naïve question of economists at the time – “how come nobody saw this coming” – has yet to be answered.

As Andy Haldane, chief economist at the Bank of England, pointed out in a recent lecture, economic models provided an exceptionally poor guide to economic dynamics at the time of the financial crisis. Even after the crisis erupted, the profession seemed oblivious to its likely consequences. Virtually all the economic forecasts produced in the final quarter of 2007 – that’s after the collapse of Northern Rock - were not just mildly wrong about the coming year, but spectacularly so. Few saw any possibility even of a downturn, let alone the worst recession since the 1930s.

Mainstream economic modelling failed spectacularly during the financial crisis and has largely failed since

This failing has been explained by the Nobel prize winning economist Robert Lucas thus: “The simulations were not presented as assurances that no crisis would occur, but as a forecast of what could be expected to occur conditional on a crisis not occurring”. Thanks for nothing.

A somewhat similar excuse is proffered by HM Treasury for its ill judged analysis of the short term consequences of a vote for Brexit. This was not a prediction, but a “scenario”, it is claimed, based on two assumptions that turned out to be wrong – that Article 50 would be immediately triggered, and that there would be no countervailing monetary action by the Bank of England. Yet in truth, it was always obvious both that Article 50 would not be immediately triggered, and that the Bank of England would indeed take action to support the economy.

A stone when dropped will always fall to the ground. Human behaviour is by contrast far less certain, the result of a complex series of interactions which will always be inherently unpredictable, or what Mervyn King, former Governor of the Bank of England, has called “radical uncertainty”. The trouble with much modern economic modelling is that it assumes the laws of physics can indeed be applied to economics, or that behaviour will always respond to given inputs in a particular way. Time and again this has been proved incorrect.

The risks of this serial inability to diagnose what’s happening in the economy lie not just in the social costs of extreme events, or in wrong-headed policy response to them. It has also made mainstream macro-economics the object of political derision, which is in turn undermining public trust in key aspects of institutional and policy orthodoxy, including central bank independence and inflation targeting, which by and large have served us well.

Already we see some of this backlash in Trumponomics, where established norms, evidence and constraints are rejected in favour of policy based on instinct and narrowly perceived American self interest, including protectionism. These cranky alternatives threaten even worse outcomes than the faulty economics of the past.

Mr Haldane sees some reason for hope in reformed modelling, and in particular in so-called “Agency Based Models”, which take account not just of the observable environment, but also the behaviour of other agents which interact with it. Big Data promises to give these models even better predictive qualities.

Long applied to air traffic control, disease prevention, pharmaceutical drug trials and many other practical fields, use of ABMs in macro-economics is still very recent and far from commonplace. We can but hope they represent the great leap forward proponents claim.

One notable sceptic is the economist Paul Krugman, who claims that the old models didn’t fail, or rather that his own relatively simplistic Keynesian modelling predicted almost exactly the failure in post-crisis macro-economic policy. Ah, the path not taken. The beauty of this line of argument is that we’ll never know whether a different approach would have worked better.

Whatever the answer, economists need to be far more circumspect about prediction, as well as the uses their work are put to by the political class, where there is a growing tendency to cite the “experts” who seem to support the party line as true visionaries and dismiss the ones who don’t as useless propagandists. Pick your poison.

But let’s not entirely despair; undeterred by the low regard in which the discipline is held, there are apparently more students applying to do economics at university than ever. Economics may have lost its mojo, but plainly not yet its fascination.