‘We Only Postponed The Day Of Reckoning’

Economist-cum-technocrat Deepak Nayyar is viewed as an influential observer of the economy and a selective critic of liberalisation. He was the chief economic advisor to the government during the tumultuous period between 1989 and 1991, when India negotiated with the International Monetary Fund. In a rare interview, Nayyar—emeritus professor of economics at the Jawaharlal Nehru University in Delhi—took questions from Sunit Arora published in Outlook India:

Sunit Arora: Professor Nayyar, is India facing a balance of payments crisis?

Professor Deepak Nayyar: We are indeed in a crisis. In the past three months, confidence has been strongly undermined. India’s balance of trade deficit (10 per cent of GDP) and current account deficit (4.8 per cent of GDP) are both at levels that are unsustainable in terms of fundamentals. If you compare this with the past in India, or the present in other emerging economies, you would recognize how serious the situation is. It is as clear as daylight that we cannot continue to live beyond our means year after year.

But why has the mood shifted from abject despair to seeming euphoria?

The panic lifted when US Federal Reserve Chairman Ben Bernanke announced in mid-September that he was going to defer the progressive withdrawal of quantitative easing. It was not the magic wand of Raghuram Rajan at RBI that stabilized the rupee It was this exogenous event in the US! Essentially, the problem lies in our flawed strategy of using foreign (portfolio) investment inflows to finance the current account deficit. Given this approach, we must be prepared to accept the ebbs and flows of global finance. However, we cannot claim we are victims of global finance. Of course, most emerging economies were hurt by Bernanke's decision. But we chose this path. And our fundamentals are distinctly worse 

What do you think is an appropriate value of the rupee?

The rupee was somewhat over-valued at Rs 55/$ . We have had high inflation for three years, much higher than in the outside world. Hence, this needed to be corrected. But the sinking to Rs 70/$ was too much of a correction. Clearly, there is no assurance the rupee will remain at current levels of Rs 62/$. When the Federal Reserve Board meets next, it is almost certain that they will announce a phased withdrawal of quantitative easing. There could then be a repeat performance of capital outflows from India. It is simply a matter of time. We have only postponed the day of reckoning.

The government continues to insist that we don’t need to go to the IMF.

"It would be prudent and wise to explore seeking an arrangement with the IMF—even if this cannot be in the public domain for obvious political reasons.”

The government cites two reasons for their comfort: the exchange rate has stabilized, and foreign exchange reserves at $275 billion are large enough. The exchange rate could slip again. And the comfort implicit in these reserves is illusory. Simply put, short-term debt and liabilities that can be withdrawn on demand are much larger than our reserves. The private corporate sector has to repay $ 170 billion before end-March 2014. And the outstanding stock of portfolio investment is much larger. If there were to be capital flight, just as we had in 1990, the reserves would vanish—and vanish quickly. In the past, many countries in Latin America, East Asia and elsewhere have lost more than $100 billion of foreign exchange reserves in a fortnight during financial crises.

So, do we need to go to the IMF?

It is important to recognize that the IMF simply does not have the resources to finance such large current account deficits let alone combat capital flight. But the IMF is a lender of last resort. Its imprimatur tends to stabilize confidence in international financial markets. The government must recognize that the present situation is at least as serious, if not worse, than what it was in 1990-91. In these circumstances, it would be both prudent and wise to explore the possibilities of an arrangement with the IMF, even if this cannot be in the public domain for obvious political reasons. The government must recognize that terms are always better before a crisis implodes, and always much worse thereafter. Obviously, this would be a back-up plan, tactical rather than strategic, should the need for contingency finance arise. The government must also explore alternative emergency financing possibilities such as swap arrangements with other central banks.

How would you rate the UPA’s management of the economy?

The macro-management of the economy during the tenure of UPA-II leaves much to be desired. The management of the balance of payments situation has been poor. This problem, which has been building up for three years, should have been addressed much earlier—with the same urgency as the government is doing now. The early warning signals were all there but were quietly ignored.

If you were Chief Economic Advisor, what would you have advised the government?

The irony of my life is that, in the late 1980s, I wrote about the macroeconomic crisis to come, but I was at the epicentre trying to manage it when it surfaced (in 1990-91). If I had any association with the government, starting 2009, I would heard these alarm bells. For one, I would have begun to act on accelerating rates of inflation. For another, I would have done something to ensure that the balance of trade deficit, hence the current account deficit, did not climb to these unsustainable levels. These problems did not surface overnight. For more than three years now, inflation has been gathering momentum and the balance of trade deficit has been rapidly ballooning.

Why hasn’t the UPA been able to tackle persistent and high inflation for the past three years?

“I am opposed to Raghuram Rajan’s plan to allow global banks to buy Indian ones. Banking plays a critical role in countries latecomers to industrialisation.”

I think that both the diagnosis and the prescription of the government on inflation has been wrong. The government has simply raised interest rates time and time again. This has ended up stifling domestic investment. But it has done nothing to combat inflation. Hiking interest rates would moderate inflation if rising prices are driven by excess liquidity. But when inflation is driven by supply-demand imbalances, adverse expectations, or segmented markets, monetary policy cannot address the problem. It is no surprise that it has not. Indeed, theory and experience both suggest that, beyond a point, raising interest rates does not combat inflation, just as lowering interest rates cannot stimulate investment. The persistent inflation has hurt people most of whom do not have index linked incomes. Come election time, this resentment will translate into a protest by voters against incumbent governments, wherever they are, because people hold governments accountable for inflation. The real problem now lies in the credibility of the government, now much diminished, because that is what shapes confidence, perceptions, and expectations. It is possible—although as a citizen I sincerely hope it does not happen—that markets might decide, without waiting for the people to decide at election time. If a macro-economic crisis does surface before the election, then markets would have decided on the economic performance of the government even before the people have had an opportunity to do so.

So you feel the crisis could re-appear…?

It is possible. It serves no purpose to be alarmist. Yet, it is important to be a realist. I do not see any evidence of a real turnaround, at least so far, on any of the criteria—trade deficit, current account deficit, inflation, savings, investment or growth—that shape underlying fundamentals. The only silver lining is the good monsoon. The paradox is the skyrocketing prices of food in what seems to be an abundant monsoon. The depreciation of the rupee is going to compound the problem. Imports are 25 per cent of GDP so that a 10 percent depreciation directly pushes up the wholesale price index by 2.5 percentage points, while indirect pass-through effects could add a further 1 plus percentage points.

Shifting tracks, what is your view on Raghuram Rajan’s statement on recasting norms for allowing international banks to buy Indian ones?

My view is clear. I am opposed to it. I would wish to exercise strategic control in the banking sector as it has a critical strategic importance in countries that are latecomers to industrialization. Evidence available for the past ten years, which reveals a significant decline in the share of manufacturing in GDP and in employment, suggests that there is a danger of de-industrialization in India. I would argue that the time has come for India to think of strategic industrial, trade and technology policies. There is no country that has industrialized without strategic forms of intervention. The fetishism about liberalization is overdone. It is a means of increasing the degree of competition in the economy. But its pace and sequence must be calibrated. We cannot lose sight of the ends. Industrialization is an imperative because that is our potential comparative advantage.

What is your view on the corruption scandals around the allocation of scarce natural assets?

As a concerned citizen, I can only express anguish and anger at such a blatant sharing of the spoils between the state and some corporate entities. The metaphor , crony-capitalism, is an apt description. Public Private Partnerships (PPPs) are just rhetoric. For one, there is so little progress. For another, it might simply socialize the costs and privatize the benefits. Where is it going to lead us, say in infrastructure?

Finally, where do you weigh in on the Amartya Sen versus Jagdish Bhagwati debate?

I followed the debate, but it is a red herring that poses false dilemmas. Both are concerned with outcomes—growth or equity—but neither is concerned with processes, which requires thinking about transition paths or journeys to the destination. Most importantly, we need growth with equity. Is it possible for us to promote growth when you have a State that is incapable of regulation? Similarly, is it possible for a state that cannot deliver even basic public services to implement good redistribution programmes? Efficient markets need effective governments.

Nobel Prize winners say markets are irrational, yet efficient

S A Aiyar in The Times of India

Are stock markets irrational, driven by greed and fear, subject to euphoria and panic? Or are they highly efficient indicators of intrinsic value? Both, says the Nobel Prize Comittee for Economics, with no sense of contradiction.

It has just awarded the prize jointly to economists with opposing views. Robert Shiller is famous for two versions of his book 'Irrational Exuberance'. The first version appeared in 2000 at the height of the dotcom boom, and correctly predicted that this was a bubble about to burst. The second version came in 2005 just as the housing market was skyrocketing, and predicted (again correctly) that this too was a bubble likely to burst resoundingly.

This confirmed Shiller's status as a behavioural economist. Such economists laugh at the notion that human beings are rational economic actors, as portrayed in textbooks. No, say behaviourists, humans are driven by fads, prejudices, manias, and irrational bouts of optimism and pessimism. Yet Shiller is going to share the Nobel Prize with Eugene Fama, famous for his "efficient markets hypothesis." This states that markets are like computers processing information from millions of sources on millions of economic actors, and hence produce more efficient long-run valuations than the most talented genius.

Fama's market behaviour is fundamentally random, so future trends cannot be predicted by even the cleverest investors. He implies that choosing stocks by throwing darts at a stock market chart can beat the recommendations of top experts. This has been verified by some, though not all, dartthrowing contests.

Corollary: ordinary investors must not pay high fees to experts to pick winners. Instead they should invest passively in a group of shares (like the 30 shares constituting the Bombay Sensex or Dow Jones Industrial Average), and ride these bandwagons without paying any fees. This has led to the spectacularly successful emergence of Index-traded funds (like those run by Vanguard in the US). Such funds are indexed to share groups like the Sensex or the Banks Nifty. Rather than try to pick individual winners in say the auto, pharma or realty sectors, index funds invest passively in a group of auto, pharma or realty companies. This has proved successful and popular.

Two groups criticize the efficient markets hypothesis: big investment gurus and, paradoxically, leftists viewing financial markets as instruments of the devil. Investment gurus like Warren Buffett in the US or Rakesh Jhunjhunwala in India claim to have beaten the market average handsomely, thus disproving the efficient markets hypothesis. Not so says Fama: in any large collection of investors there will always be some who perform above average and some below average - this is a matter of statistical chance, not skill. Moreover, investment gurus have so many contacts that they may have insider information enabling them to beat the market by unfair means.

As for Shiller's successful predictions, Fama says capitalism is driven by booms and busts. To predict at the height of a boom (like Shiller) that a bust will follow is banality, not genius. It is as unremarkable to predict during every bust that a boom will follow.

After the 2008 global financial crisis, the new conventional wisdom is that governments need macro prudential policies to check future financial crises, and that finance should be more strictly regulated than ever before. However, the counter is that the financial crisis occurred even though the financial sector was already the most regulated (with 12,000 regulators in the US alone). Governments had encouraged reckless lending by guaranteeing large banks and investment banks against failure, and by creating governmentbacked underwriters like Fannie Mae who shouldered any burdens caused by mass default.

Perhaps the Nobel Prize Committee is right in implying that markets can be both irrational and efficient at the same time. Since humans are irrational, they will always create markets that have booms and busts, marked by irrational optimism and pessimism. An efficient markets defined by Fama and his followers is not one that produces steady growth without booms, busts or crises. It is efficient only in the limited sense that, whether the markets are calm or irrational, they represent the processed information of millions of actions of millions of actors, and this is inherently more efficient than the efforts of any individual investor.

The argument is analogous to the one against communism or dictatorship. Communists believed that the great and good politburo, motivated entirely by the public interest and not profit, would run the economy better than the chaos, irrationality and imperfections of the capitalist market. Yet the market, with all its flaws and irrationality, proved infinitely more efficient.

Fama holds that this is true of financial markets too. This is compatible with Shiller's analysis. Markets can be both irrational and efficient.

Time to explode the myth that the private sector is always better

Steve Richards in The Independent

The deeply embedded assumption that a slick, efficient, agile, selfless private sector delivers high-quality services for the public is being challenged once more in darkly comic circumstances. Those inadvertent egalitarians from the security firm G4S have failed to recruit enough security officers so it seems anyone will be able to wander in to watch the 100 metres final. Or at least that would have been the case if the public sector had not come to the rescue in the form of the army.

What an emblematic story of changing times. From the late 1970s until 2008, the fashionable orthodoxy insisted that the public sector alone was the problem. Advocates of the orthodoxy took a knock or two when the banking crisis cast light on parts of the pampered, sheltered and partially corrupt financial sector. Now we get a glimpse of incompetence and greed in another part of the private sector. As light is shed wider and deeper, we keep our fingers crossed that the public sector can rescue the Olympics from chaos.

The pattern is familiar but has been obscured until the arrival of this accessibly vivid example, an Olympic Games staged in a city paranoid about security without many security officers. For decades, private companies were hired on lucrative contracts for projects that the state could never allow to fail. If the companies delivered what was required, they earned a fortune. If they failed, the taxpayer found the money to meet the losses and those responsible for the cock-up often moved on to new highly paid jobs.

The lesson should have been learnt when Labour's disastrous Public Private Partnership for the London Underground collapsed, as this was another highly accessible example of lawyers, accountants and private companies making a fortune and failing to deliver. The Underground could never close, so all involved knew that in the event of failure, the Government or the Mayor of London would be forced to intervene. Boris Johnson described the arrangement at the time as "a colossal waste of money".

He was right, but that has not stopped his colleagues in Government looking to contract out to the private sector at every available opportunity. Andrew Lansley had hoped to make the NHS a great new playground for companies seeking an easy profit. He still might do so. Expect Michael Gove's so-called free schools to become profit-making enterprises if the Conservatives win the next election, and perhaps the academies, too. Maybe there will be a G4S-sponsored school.

G4S already runs prisons and some of the police operations that are being increasingly contracted out to private companies. The welfare-to-work contract secured by another company, much hailed by gullible ministers when the deal was announced as an example of efficiency and effectiveness, is already under critical scrutiny.

A fortnight ago, I argued that we are living through a slow British revolution partly as a result of the financial crisis and the exposure of reckless, unaccountable leadership from the City. The era of light regulation that allowed some bankers without much obvious talent to make a fortune is over. Now, slowly, the assumption held from Thatcher to Blair to Cameron that the delivery of public services should lie with the private sector is being overturned, too.

As is always the case in British revolutions, the change is being driven by startling events and not by political leadership. The Coalition still burns with an ideological zeal formed in the 1980s, the Conservative wing at one with Orange Book Liberal Democrats in their indiscriminate hunger for a smaller state and their undying faith in the private sector.

At the top of both parties, there are crusading advocates of an outdated vision that places too much faith in the likes of G4S and not enough in the potential dependability of a more efficient and accountable public sector.

This is not to argue that the public sector is perfect. Parts of it are complacently inefficient and paralysed by a sense of undeserved entitlement. The Coalition deserves some credit for seeking to increase transparency and accountability in an often over-managed and wasteful sector. In the case of the Olympics debacle and other equivalent deals, part of the culpability lies with government departments that negotiate on behalf of the taxpayer.

Last week, The Independent revealed that there had been no penalty clause in the G4S contract. On Tuesday, its unimpressive chief executive told the Home Affairs Committee that the company still expected to collect £57m for its contribution to the Olympic Games, an expectation that brings to mind once more that damning, ubiquitous phrase from the old Britain: "rewards for failure".

Who draws up these contracts? Which ministers sign them off? Why is their instinct always to outsource when there is now a mountain of evidence that failure follows?

Instead of focusing on the arduously unglamorous task of making the public sector more efficient and adaptable, ministers, like their New Labour predecessors, prefer still the deceptive swagger of the incompetent entrepreneur. The gullibility is more extraordinary now we finally get to know more about these supposed geniuses. Senior bankers earning millions stutter hesitantly when questioned by unthreatening MPs on select committees, incapable of articulating a case. Nick Buckles from G4S was so thrown by the Home Affairs Committee that he lapsed into a debate about whether the few security guards he had managed to hire spoke "fluent English", claiming not to know what such a term might mean. One of the great revelations since Britain's slow revolution began in 2008 is how many unimpressive mediocrities had risen in the unquestioning, unaccountable darkness that, until recently, acted as a protective layer for parts of the private sector.

But in the end look who is ultimately held to account. The Home Secretary, Theresa May, was called to the Commons twice this week to answer questions about what went wrong. She will be back in September. A government can outsource but it will still be held responsible, quite rightly, for the delivery of public services.

So political survival should motivate ministers in future to draw up much tighter deals with companies and to focus more on improving the public sector rather than expensively by-passing it. The voters have had enough of these abuses and yet, trapped by the past, some ministers show an ideological inclination to be abused for a little longer.

Neoclassical Dogma – : How Economists Rationalise Their Hatred of Free Choice

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

What if all the world’s inside of your head
Just creations of your own?
Your devils and your gods
All the living and the dead
And you’re really all alone?
You can live in this illusion
You can choose to believe
You keep looking but you can’t find the woods
While you’re hiding in the trees
– Nine Inch Nails, Right Where it Belongs

Modern economics purports to be scientific. It is this that lends its practitioners ears all over the world; from the media, from policymakers and from the general public. Yet, at its very heart we find concepts that, having been carried over almost directly from the Christian tradition, are inherently theological. And these concepts have, in a sense, become congealed into an unquestionable dogma.
We’ve all heard it before of course: isn’t neoclassical economics a religion of sorts? I’ve argued here in the past that neoclassical economics is indeed a sort of moral system. But what if there are theological motifs right at the heart of contemporary economic theory? What does this say about its validity and what might this mean in relation to the social status of its practitioners?

Let us turn first to one of the most unusual and oft-cited pieces of contemporary economic doctrine: rational expectations theory.

Rational Expectations: Irrationality and an Encounter with the Godhead

Rational expectations is indeed an obscure doctrine. It essentially holds that people operating within a market generally act in line with the expectations of neoclassical theory. This tautology – for it is a tautology – can be traced back to Adam Smith’s ‘invisible hand’ which we explore in more detail later on.

But this goes beyond simple tautology. The neoclassical assumptions are themselves especially stringent and seem to be wholly counterfactual to any observer of human behaviour. Rational expectations theory expects people to act, well, rationally. More specifically it assumes that people always act in order to ‘maximise their utility’ and that such actions result in optimal behaviours that ensure that prices are always perfectly in keeping with what they ‘should be’ – that is, an equilibrium price that perfectly balances supply and demand. Prices then become a pristine and perfect measurement; they translate consumer desire perfectly and are beyond question.

Utility maximisation is a strange doctrine that goes right to the heart of rational expectations theory. It assumes that a fixed value can be placed on the satisfaction people derive from the things they buy. It also assumes – implicitly – that people are in some sense aware of this value and that they undertake their actions rationally in accordance with their perception of it.

At a glance this seems outlandish. Take consumption as the most glaring example. Anyone who has ever encountered any sort of marketing knows well that people don’t act in a perfectly rational manner. People often consume in line with what they perceive to be group expectations. Marketers and corporations take advantage of this and use it as leverage to jack up prices on certain goods. For example, are my brand name jeans really worth that much more in tangible terms than a non-brand names pair of jeans? I would say not.

Economists might counter this by arguing that consumers are still acting rationally insofar as their responding to marketers and brand names helps them further their social esteem: it gives them ‘social capital’ and it is this that the marketer is selling. To argue this is to fundamentally misunderstand the psychology of the consumer. The consumer may indeed identify with the group through the consumption of the product, however this is a deeply emotive act – not one in which the consumer cynically calculates that the product might enhance his or her ‘social capital’. It is not a rational response to the ‘social mores’ that the marketer is selling but rather an irrational response triggered by certain stimuli.

Marketers have understood this for nearly a century. Consider the case of a Lynx ad run a few years ago during the World Cup (here is the ad) – note also that Lynx have been running similar ads for years (which presumably means that this campaign has proved so effective that they have no need to fundamentally change it).

There is a certain amount of group identification present in this ad certainly (doesn’t every guy want to be the Don Juan who ‘scores’ all the chicks?), but there is definitely a deeper strata operating here. I don’t think I need to even point this out. The ad says it quite explicitly: ‘Spray more, get more’. This means that not only will you ‘get more’ women if you use Lynx, but also that if you literally spray on more Lynx you will literally get more women – a fantastic assertion.

Look again at the ad. Note how the guy is using an awful lot of Lynx. Indeed, it almost appears as if more women appear as he sprays on more of the deodorant (if one were to be terribly cynical one might read his end reaction in the ad as a sexual climax induced by his extremely liberal use of the deodorant). Anyone who has stood at a bar in a nightclub next to a guy smelling extremely heavily of Lynx will not doubt that this campaign has been at least somewhat effective.

The idea – a classic in marketing – is that not only to tie the consumer to the brand through group identification and the promise of sexual fulfilment, but to actually influence how the consumer uses the product itself. This ensures that the consumer will purchase more of the product because they will consume it faster. To claim that this behaviour is somehow rational is to pervert the English language itself. This behaviour is strongly irrational and those that attempt to manipulate it know this better than perhaps anyone else.

While we won’t go too far into the argument here, these observations can safely be transferred to most of the decisions that people make in all of the spheres dealt with by rational expectations theory. From direct investment to the purchase of stock to so-called inflation expectations, all have a strongly irrational aspect that is often manipulated by institutions for political and economic ends (the amount of institutions attempting to manipulate inflation expectations at the moment is quite incredible).

One example might be that of housing. During the boom years people invested money in housing not just because they might see a profitable return, but also because it became fashionable to own property – while the following clip is from a comedy show, the social observation is a sound one as far as Irish society during the property bubble is concerned. The boom rested not simply on the fact that it became ‘cool’ to own a house (this would be the social identification element as identified in the above clip), but also because being a homeowner has certain emotive overtones (having a family, being free from one’s parents etc.). These social expectations and emotive responses are key components not only in all speculative bubbles, but in all so-called market activity.

The fundamental point here is that people – be they consumers or producers, investors or forecasters – often act in an almost wholly irrational manner; one that is quite open to manipulation. And once we allow for this the very premise upon which rational expectations theory rests upon falls to pieces.
This is all very interesting, but it has nothing to do with theology, surely. Well, it is in the next key tenet of rational expectations theory that we truly encounter the Godhead.

Rational expectations theory assumes that people always operate on a complete amount of information. Economists call this ‘forecasting’ – although they might call it ‘crystal-ball gazing’. They do not assume that all consumers forecast perfectly at all time. However, they do assume that when any forecasting errors are made they are simply anomalies. This paper sums it up quite nicely:

The hypothesis of rational expectations means that economic agents forecast in such a way as to minimize forecast errors, subject to the information and decision—making constraints that confront them. It does not mean they make no forecast errors; it simply means that such errors have no serial correlation, no systematic component.

The idea here is that all economic actors have access to almost perfect knowledge of economic variables over time (prices, inflation etc.). True the above author qualifies that such forecasting is ‘subject to information and decision’** – which is more than many other economists allow – but this is a smokescreen. If we assume that market actors do not make mistakes in a given market then they must, by default, have access to almost perfect knowledge of that market; otherwise, to say that they don’t make mistakes is silly. If they were to have incomplete information then they would have to act, at least to some extent, on their gut instinct and so would, by definition, not be acting wholly rationally.

In rational expectations theory when market actors get market variables incorrect or act in an ‘incorrect’ manner on these variables this error is not taken to be indicative of some underlying uncertainty in their action, but simply an anomaly; an exception to the rule. Economic actors are assumed to have access to near perfect information, not just about the present but about the past and future as well.

Scratch a little deeper and you’ll find that this is an even more incredible assertion than it first appears. Rational expectations theory essentially assumes that consumers are omniscient beings – or at least, when they are acting ‘normally’ they are omniscient. This is where we encounter truly theological motifs in the edifice of neoclassical economics.

In many theologies, God is assumed to have perfect knowledge. And in order to gain access to this knowledge one needs only to try to build one’s relationship to God onto a higher plateau. In rational expectations it is assumed that individuals can indeed make mistakes – in theological terms: they can Sin – but these mistakes are never systemic – in theological terms: individuals are always on the way toward Salvation. As long as the individual keeps with the ‘tenets’ of the theory (which is presupposed), Sin is minimised and the individuals acts in line with the being possessing perfect knowledge.

The being of perfect knowledge is here not thought of as ‘God’ per se, but instead is given the name ‘The Market’. On a purely intellectual level the ideas seem almost identical. Both are overarching principles governing our lives, both are generally ‘followed’ unless perverse deviations (Sinners) crop up and both are perfect information processors.

We will return to this when we pick up Smith’s theory of the ‘invisible hand’ – a theory from which this all stems. For now let us turn to the true neoclassical Godhead: the efficient markets hypothesis.

The Efficient Markets Hypothesis: The Godhead Embodied

As we shall see shortly, ‘the Market’ is and always was a strongly theological idea. However, it is in the efficient markets hypothesis where the Godhead is truly to be located today.

Whereas the rational expectations model of the economic actor assumes that he or she is always in some sort of relationship with a being of perfect knowledge, the efficient markets hypothesis points the way to this divine being itself.

To really boil it down, the efficient markets hypothesis essentially states that all information is always already built into markets and hence they operate perfectly in line with how neoclassical theory would expect them to operate (i.e. with supply and demand in perfect equilibrium and prices reflecting this perfectly). In a way, the efficient markets hypothesis assumes that markets are made up of the actors we previously encountered in the rational expectations model. Since, as we have already seen, these actors always act in a predictable way, a conglomeration of them will process information perfectly.

The question to be asked is of the ‘chicken and egg’ variety: do these theories begin with the rational actor and then build upon this to form the efficient markets theory OR do these theories begin with the assumption of an overarching arena of rationality which is called ‘the market’ and then assume peoples’ actions based on this abstraction?

I would argue that the latter is the case. As we shall later see, if we trace these ideas right back to their roots we find that the theory of markets is far more primal than the theory of the rational individual – the latter is, in many ways, derived from the former.

So what status does this give the being that we call ‘the Market’? Well, if it is a being that is presupposed to exist while only being seen through its effects and is given the power to direct the behaviour of individuals, then it is surely of the theological variety. It is the Godhead embodied.
Many commentators – including this blog’s editor Yves Smith in her book ECONNED – have pointed out that the efficient markets hypothesis was used by policymakers to justify their cutting back on regulations and allowing ‘the Market’ to operate without constraint. These commentators have pointed out that it was this policy prescription that led to the current financial crisis.

It is also to be pointed out that these prescriptions were always undertaken with a kind of faith. Past experiences had cast into doubt that financial markets operated in line with the efficient markets hypothesis and yet those who pushed for deregulation were true believers in the hypothesis; they acted as if they were in a sort of irrational reverie, a suspension of historical remembrance wholly driven by their beliefs. It should not be surprising then that we find this idea to be a very close approximation of certain religious ideas and ideals.

The idea that there might be some overarching being – whether called ‘God’ or ‘the Market’ – that is directing all our activity and through whom we can be sure our actions are just and righteous, is a very attractive one. Like the religious ideas of yore it can both justify our actions when they are ethically questionable – we can assure people that such actions are in keeping with the Market’s Divine Will – and can assure us that the actions we undertake are reflected in and through some higher ideal – in this case a perfectly rational being we call ‘the Market’.

These ideals can also justify our actions after the fact when the God, so to speak, has failed. When this occurs – as has certainly happened today – devotees can assure the general public and their colleagues that it was simply a glitch, perhaps a testing of our faith and that we should never question the Market’s Will. Some of the more extreme devotees might even suggest that we have Sinned too greatly and that we have not followed the Market’s Will adequately enough. More deregulation is needed otherwise we might incur further punishment from the Divine Wrath.

Lying behind rational expectations theory and the efficient markets hypothesis is Adam Smith’s old notion of the ‘invisible hand’ and it is to this we now turn.

The Invisible Hand and Predestination

For by grace you have been saved through faith, and that not of yourselves; it is the gift of God, not of works, lest anyone should boast. For we are His workmanship, created in Christ Jesus for good works, which God prepared beforehand that we should walk in them – Ephesians 2:8-10

It was on this passage of the bible that the famous Protestant theologian Martin Luther based his idea that human beings had no free will. They were always subjects of God, bound up with Him and merely danced to whatever tune he played. This is the essence of the Protestant idea of Predestination. God has a plan for each and every one of us and we are just cogs in his great harmonious machine. It is His invisible hand that controls our actions and our destinies.

The importance of the invisible hand in the work of the first modern economist Adam Smith is hotly debated, since he used the metaphor only three times in his whole work and even then he used it only loosely. However, it is thought by many – and rightly, I think – as distilling the main thrust of his work in a single, useful phrase.

For Smith, the Market should be free to largely act autonomously. It ironed out its own inconsistencies and operated effectively and harmoniously. But what place did this leave for the individual?

Many today claim that Smith was the great prophet of human freedom. Yet if his theories are read as being wholly deterministic this surely cannot be the case. If the Market acts autonomously, unconsciously dictating all our actions then is there really space for liberty in classical or neoclassical economic theory? I would argue not.

The invisible hand permeates all aspects of neoclassicism. In a seminal paper entitled ‘Situational Determinism in Economics’ the philosopher of science Spiro Latsis shows that the whole neoclassical research program relies on an overarching determinism which he refers to as ‘situational determinism’. What he means by this is that, given a certain situation that a particular individual might find him or herself in, they will always necessarily choose one path – their behaviour will always follows a certain given direction.

This is, of course, the invisible hand at work. The person is directed or guided by an invisible force that leads them to undertake one action and avoid another. This should also be recognised as one of the fundamental aspects of rational expectations theory as outlined above: the individual is assumed to always act in a specific way and any other actions are thought to be ‘deviations’.

The invisible hand is truly the hidden thread tying together all sorts of neoclassical theories – from rational expectations to the efficient markets hypothesis. And in this it is simply a reiteration, in quote-unquote ‘secular’ form, of an age old Protestant theological assertion. What we get is a view of a world governed and controlled by a mystical and invisible force that sorts everything out for us. Everything operates without human governance, the world adheres to a set of laws handed down by an invisible agency; everything in its right place. This is Predestination pure and simple.
(It should be noticed that Austrian School ideologue Ludwig von Mises recognised that the invisible hand in Smith was in fact an image of God. He held, however, that secular reasoning led in this direction and did not see a problem with this. One can only assert that von Mises was more self-aware than other believers. See: note 3 on page 147 of Mises’ ‘Human Action’ – an ironic title given the thrust of our present discussion).

In modern neoclassical theory we find this structure operating mainly through the two theoretical postulates discussed in the first and second parts of this piece.

The efficient markets hypothesis postulates that there is an overarching and invisible force that cannot err. This is an image of a God controlling the world and ensuring that order emerges automatically out of chaos. All of us individuals are then conceptualised as living inside of this holy sphere. This leads to the assumptions of rational expectations theory.

In rational expectations theory, individuals are taken to act in the way assumed by neoclassical economics: that is, they rationally seek to maximise their gain in a particular way etc. The theory allows that they sometimes make mistakes, but these are thought of as ‘deviations’ and are never allowed be the norm. The Market, being infallible, omnipotent and unable to err, effectively ensures that individuals are not allowed to make mistakes in any systematic way. To cast this in theological language: God, being infallible, omnipotent and unable to err ensures that individuals are not able to Sin in any systematic way. While Sinning does take place, the overall thrust is for Man to follow the path that God has laid out for him.

The neoclassical paradigm offers its adherents a very attractive theology. It allows them to look at the world through a remarkably powerful set of rose-tinted glasses. It assures them that everything is okay – provided regulators and Sinners don’t get into positions of power – and that order and harmony will be established by an over-arching, quasi-external power. It gives its adherents a being that they can, in a very real sense, worship. It gives them a moral code that they can follow and that they can use to justify their actions, even when these appear to an external observer as being disgusting, idiotic and objectionable.

Dogmatism and Its Dangers

Perhaps this last point is the key one. The most dangerous personality trait of dogmatic religious devotees is their ability to insist that their extreme views are pure truth and that any action they undertake, no matter how destructive and stupid, are always already sanctioned by a higher power.
In his modernist classic ‘Ulysses’, there is a beautiful sentence in which James Joyce sums up the hypocrisy of religious dogmatists who use their fixed beliefs to justify actions that they might not be able to otherwise undertake in good conscience. Speaking of Oliver Cromwell’s brutal military campaign in Ireland in the mid-seventeenth century Joyce writes:

What about sanctimonious Cromwell and his ironsides that put the women and children of Drogheda to the sword with the bible text ‘God is love’ pasted round the mouth of his cannon?

What about him indeed? Such is the epitaph we might one day see on the tombstone of that strange secular religion that is neoclassical economics – although rather than the text ‘God is love’ pasted round the mouth of its collective cannon, there are instead written the words ‘the Market is always right’.

** As we will soon see, the meaning of the word ‘decision’ here is very shaky. How can a deterministic theory which claims to know how people will act allow them to have the power to make a decision? If they have the power to make a decision then, by default, this decision will be uncertain and no overarching theory will be able to capture it. By making reasonable qualifications to accompany an unreasonable theory the above author unwittingly destroys the theory itself.

My Weltanschhaung - 14/02/2012

Being Valentine's Day, I am reminded of the guy who spoke at IIT-Kharagpur's humour festival - "Yeh Valentine day kya hai? Yeh to ek soone ka hiran hai jo dhanush banane wale companiyon ne bazaar me chhod rakha hai.! Translation, 'This Valentine's Day business is a golden deer released in to the market by firms selling bows'.

I am shocked at the competence of the managers of Jet Airways and Kingfisher Airlines who have not paid their staff salaries for two months. These are supposedly market savvy, professional and efficient firms.
What shocks me the most is the statement by Sanjay Aggarwal CEO of Kingfisher,  "We got hit by a couple of large unanticipated payments which had to be addressed on an emergency basis." 
How can you be unaware of such large payments coming up? Is there no penalty for not paying salaries on time? I think both these firms tactics aim to scupper any relief and rescue of Air-India, stating that they all need relief from the government.

I am surprised that the Israeli Prime Minister knew who attacked his staff in New Delhi even before the local police. The Israelis and its allies have been assasinating Iranian nuclear scientists without the same publicity though. The bomb blast in Delhi may be aimed at preventing India from signing up a bilateral treaty with Iran. Will the Indian government buckle under the pressure?

Who to blame for the Great Recession?

In 2000 it was the $164bn (£103bn) AOL takeover of Time Warner in America. In 2007 it was the-then Sir Fred Goodwin's £49bn acquisition of ABN Amro that signalled that the markets had peaked and were about to crumble.

Every financial crisis has its totemic moment; a decision that even at the time seems to defy logic and in retrospect is seen as an act of gross stupidity. Yet it takes more than one individual banker, no matter how powerful, to make a crisis and when the historians come to chronicle the Great Recession of 2008-09 the list of guilty men and women will include more than one former knight of the realm.
Here, then, is a (far from exhaustive) list of those who might be considered most culpable – who caused, exacerbated or failed to prevent the worst downturn in the global economy since the 1930s.

Alan Greenspan

Laughably given an honorary knighthood in 2002 for his "contribution to global economic stability", Greenspan's responsibility for the crash cannot be underestimated.

A fanatical believer in the self-righting qualities of financial markets, he was the bubble king who allowed the dotcom boom of the late 1990s to get out of hand and then, when plummeting share prices pushed the economy into recession, started the whole process off again, this time in the housing market.

As chairman of the Federal Reserve, he cut interest rates and left them at rock-bottom levels for two years.

Cheap borrowing costs encouraged Americans to load up on debt to buy homes, even when they had no savings, no income and no job prospects.

These so-called sub-prime borrowers were the cannon fodder for the biggest boom-bust in US history. The housing collapse brought the global economy to its knees.

Sir Mervyn King

Britain was mini-me to the US in the days of grand illusion before the crash, having its debt-fuelled party where growth was concentrated in the speculative sectors of housing and finance.

King became Bank of England governor in 2003, and while he has subsequently been one of the most pro-active central bankers with a refreshingly robust approach to the banks, the case against him is that he failed to "lean against the wind" during the economic upswing, leaving interest rates too low, and then waited too long when the economy was nosediving into its most severe postwar recession before cutting bank rate.

Under the government's tripartite system of regulation, the Old Lady was supposed to ensure developments in the City did not pose a systemic risk to the economy. It failed in that task.

Gordon Brown

We have abolished Tory boom and bust, Brown said repeatedly in his 10 years as chancellor of the exchequer. He hadn't.

His last big speech before becoming prime minister, made at the Mansion House in June 2007 just as the financial crisis was about to break, praised the bankers for their remarkable achievements and predicted "the beginning of a new golden age for the City of London". It wasn't.

Brown presided over the loss of a million manufacturing jobs and an ever-widening trade deficit while cosying up to the City. He used to quip that there were two types of chancellors: those who failed and those who got out in time. He got that one right.

Bill Clinton

One Democratic president, Franklin Roosevelt, put a cage round Wall Street after its excesses in the 20s led to the Wall Street crash and the Great Depression. Another Democrat, Bill Clinton, gave Wall Street the cage keys.

After a fierce lobbying campaign, Clinton agreed to repeal the Glass-Steagall Act, which ensured a complete separation between investment and retail banks. The move heralded the coming of superbanks, huge behemoths that took in retail deposits and used them to take highly-leveraged punts in the markets.

To make matters worse, Clinton beefed up Jimmy Carter's 1977 Community Reinvestment Act to force lenders to take a more relaxed approach to disadvantaged borrowers. Liberalised banks plus millions of new sub-prime customers equalled one big problem.

Eugene Fama

The economics profession failed to cover itself in glory in the run-up to 2007. Not only did economists fail to spot that financial institutions were loading themselves up with vast quantities of toxic sub-prime debt, most of them thought it was theoretically impossible for a crisis to happen.
In large part, responsibility for that lies with Fama, a Chicago University economics professor who in the 70s came up with the efficient markets hypothesis (EMH), which stated that financial markets price assets at their true worth based on all the publicly available information, encouraging the belief that the best thing to do was to pile in when prices were rising. Bubble-think, in other words.

Ronald Reagan and Margaret Thatcher

Just as many trends in modern popular music can be traced back to the Beatles, so politics was shaped by the activities of Reagan and Thatcher, the Lennon and McCartney of deregulation, market forces and trickle-down economics.

The changes pushed through in the US and the UK in the 80s removed constraints on bankers, made finance more important at the expense of manufacturing and reduced union power, making it harder for employees to secure as big a share of the national economic cake as they had in previous decades.
The flipside of rising corporate profits and higher rewards for the top 1% of earners was stagnating wages for ordinary Americans and Britons, and a higher propensity to get into debt.

Hank Paulson

The US treasury secretary in 2008, Paulson was the Sir Anthony Eden of the financial crisis. He had all the necessary credentials a Republican president would consider necessary for the job – chief executive of Goldman Sachs with an MBA from Harvard. He was considered the brightest and best of his generation. Like Eden over Suez, he was faced with a monumental challenge. And he blew it.
Paulson's big mistake was to put Freddie Mac and Fannie Mae into conservatorship, wiping out the stakes of those who had invested $20bn in the two government-backed mortgage lenders over the previous 12 months.

Unsurprisingly, there was no great rush among private investors to rescue Lehman Brothers when it ran into trouble the following week, and when the US treasury allowed the investment bank to go bust every financial institution in the world was seen as at risk.

Fred the Shred destroyed a bank; Paulson triggered the biggest economic downturn since the Great Depression.

Kathleen Corbet

No rogues' gallery of the crisis would be complete without a representative of the credit rating agencies. These were the bodies that took fees from the banks while giving the top AAA rating to collateralised debt obligations, the hugely complex financial instruments that bundled together the toxic sub-prime mortgages with the sound home loans.

Corbet was CEO of Standard & Poor's, the biggest of the rating agencies, and she left her post in a "long-planned" move in August 2007 just as the financial markets were shutting down.

The justification for the top-notch ratings was that the poor-quality loans would be lost in the mix, but when the crisis broke the reality was more like a food scare, in which supermarkets know there are a few dodgy ready-made meals on their shelves but must bin the lot as they are not sure which ones they are.

Phil Gramm

"Some people look at sub-prime lending and see evil," said this senator in a debate on Capitol Hill in 2001. "I look at sub-prime lending and I see the American dream in action."

Gramm, who thinks Wall Street a "holy place", was the main cheerleader in Congress for financial deregulation, putting pressure on the Clinton administration to ease restrictions – not that it needed much persuading.

The fact that he had been the biggest recipient of campaign fund donations from commercial banks and in the top five for donations from Wall Street from 1989 to 2002 was, of course, entirely coincidental.

The bankers

Was it Fred Goodwin at RBS or Adam Applegarth at Northern Rock – the first UK high street bank to suffer a full-scale run on its branches since the 1860s? Was it Dick Fuld, the man in charge at Lehman Brothers when it went belly-up? Jimmy Cayne, who spent the first month of the crisis playing bridge rather than running Bear Stearns?

Or Stan O'Neal, whose attempts to rid Merrill Lynch of its fuddy-duddy image saddled the bank with $8bn of bad debts?

How about Andy Hornby, the whizzkid running HBOS? Or perhaps the man chosen by Gordon Brown to be HBOS's white knight – Sir Victor Blank, chairman of Lloyds?

Choose any one from a very long list.

Learning batting from David Warner

Ed Smith

On Sunday, I fly to Adelaide for the fourth Test between India and Australia. I'm due to arrive just in time for the first ball. I hope the plane isn't late: David Warner might have scored a hundred by lunch.

In smashing 180 off 159 balls in Perth, Warner proved quite a few people wrong - not least those who said that Twenty20 would never produce a Test cricketer. Warner, of course, played T20 for Australia and in the IPL long before making the step-up to Test cricket - well, I suppose it's up to him to judge whether it's a step up. 

We've all heard the arguments against the Warner career path: that T20 ruins technique rather than developing it, that you have to learn to bat properly before you can learn to smash it, walk before you can run etc.

But the naysayers may be wrong. The Warner story reveals deep truths about how players bat at their best. In fact, I think it is time we reconsidered the whole question of what constitutes good technique.

Cricket gets itself in a tangle about the word. In football, technique is short-hand for skill. Pundits explain how Cesc Fabregas' brilliant technique allows him to make the killer pass or eye-catching volley. Technique is not the enemy of flair and self-expression: it is the necessary pre-requisite. "Technique is freedom," argued the ballet dancer Vaslav Nijinsky.

Sadly, the word "technique" in cricket is often used as short-hand for controlled batsmanship, even introspection. It is true that some great technicians are very controlled players (think of Rahul Dravid - though even he plays best technically when he is positive). But it is not compulsory that good technique has to be accompanied by caution or repression. After all, Adam Gilchrist had a wonderful technique: there is no other explanation for how he managed to hit the ball in the middle of the bat quite so consistently.

In fact, good technique has a very straightforward definition: it is the simplest, most efficient way of doing something.

Andre Agassi had near-perfect technique on his groundstrokes. He could hit with exceptional power and consistency. How did he learn this technique? When Agassi was a boy, his father used to get him to hit thousands of tennis balls as hard and as cleanly as possible. "Hit it, Andre!" That was the essence of his coaching. If you learn how to hit the ball hard in the middle of the racket, you have to move your body and feet into the right positions to do so. In the same way, Jack Nicklaus summed up his approach to learning golf: "First, hit it hard. Then we'll worry about getting it in the hole."

I should have remembered Agassi and Nicklaus when I was out of form as a batsman and needed to go back to basics. Not only did I suffer prolonged periods of bad form, I would often get out in similar ways - nicking off to the slips, or getting trapped lbw. There were usually plenty of theories about what I was doing wrong. As one coach memorably put it to me, "If you stop getting caught and lbw, you'll be a top player." Er, yes: it would take great ingenuity to get bowled or run out throughout your career!

Many coaches tried to persuade me to change my shot selection. But that rarely helped. When I was nicking off, it was usually because I was driving badly rather than driving at the wrong ball. And I was a far less good player when I was knocked off my instinct to play positively. I came to realise that good form was a very simple issue, almost binary - like a switch that just needed to be clicked back on.

Here comes the difficult part that used to get me into trouble. I learnt that the best way to click the switch back on, to get back into the groove of playing well, was to practise driving on the up. You've probably guessed why it got me in trouble. Imagine a situation in which I had failed three or four times in a row, each time caught in the slips, and the coach walks into the nets and sees me…practising drives! I'd sense him thinking: "Doesn't he ever learn?"

But I knew what worked for me, and I think there are good reasons why it worked. To play at my best, I needed to get into good positions to attack. Why? Because when I was in position to attack, I was inevitably in a good position also to defend. But when I set out my stall to play a defensive shot - before the ball was even bowled - then I not only attacked badly, I also defended badly. Having the intention of defending caused me to be passive and late in my movements. The shot would almost happen to me, rather than me determining the shot.

	To play at my best, I needed to get into good positions to attack. Why? Because when I was in position to attack, I was inevitably in a good position also to defend

On the other hand, having the intention of attacking was a win-win: I defended and attacked better. I would set myself to play positively, which had the effect of giving me more time at every stage of the shot.

I think many players are the same. The key to their batting - whether it is defence or attack - is the question of intent. That has nothing to do with recklessness, or even scoring rate. Intent merely determines the messages you send to your brain. Imagine batting as a series of dominos that culminates in the ball being struck. The very first domino, the critical one that begins the whole process, is not physical, but mental. We might call it your "mental trigger movement".

I know it sounds ridiculously simplistic - technique from kindergarten - but many players find that the best mental trigger movement is setting themselves to move towards the ball to strike it back in the direction that it comes from. That does not mean you commit to lurching onto the front foot or playing a drive; you still react to whatever is thrown at you. But your intent is positive and pro-active.

Greg Chappell used the science of physiology to examine the connection between intent and good execution. He studied the preliminary movements of the world's greatest players. Though they all had unique styles and methods, their techniques shared one common thread: at the point of delivery, they were all pushing off the back foot, looking to come forward. Chappell argued that this trait gives great players optimal time to judge length. Why? Because a full ball is released from the bowler's hand early, a short ball is released later. So when batsmen set themselves for the full ball, they will inevitably have time to adjust for the short ball.

Here is my heretical conclusion: by encouraging them to have the intention of striking down the ground with a proper backlift and swing of the bat, T20 may help batsmen get into some good technical habits. Admittedly, T20 will not develop the refinements of sophisticated Test match batting, such as soft hands and the ability to concentrate for six or seven hours. But in terms of basic technique, there is a lot to be said for keeping cricket as simple as possible. The foundation is positive intent and a clear head. In short, we could all learn something from Warner.

The counter-argument is that Warner is a freak of nature, and that no one should try copying him just yet. Either way, I can't wait to watch him in Adelaide and judge for myself.