Thursday, 12 March 2009

Rationality and today's BBC bloggers

Robert Peston is revisiting the argument for the Bank of England buying shares in private companies - proposed by me in December and (the slightly more eminent) Roger Farmer in January. He points out that the Hong Kong government did this in the late 1990s, during the Asian financial crisis, and succeeded in both supporting the market and making a big profit when they resold the stakes a couple of years later.

Stephanie Flanders has a good piece about Tim Geithner's position and particularly about the IMF and other possibilities for fiscal burden-sharing between G20 countries.

Meanwhile Paul Mason has an excellent summary of the issues to be dealt with by the G20 conference in a few weeks:
Far from the emergence of a harmonised and increasingly unified world economy [globalisation] has produced a lopsided and malformed structure that is now falling apart. The low paid worker in Detroit cannot buy his new pair of trainers unless the low paid worker in Shenzhen a) makes them, b) deposits four out of ten yuan he earns in the factory into a global finance system that then c) lends the money to the Detroit trainer-buyer at virtually zero interest.
Which is mostly true, even though the four yuan which is eventually lent back to the American is not enough to pay for the two hundred yuan trainers. This phenomenon, though important, still only represents 5-10% of the American's income.

On the other hand I have no quibbles about this very insightful point:
...the value of the dollar must fall. Instead of saving, Chinese and Japanese consumers have to spend. This solution is often explained as if countries were - as they are in Sid Meier's Civilisation - represented by a single player, an all powerful government advised by wise economic men. But it is otherwise in the real world. Countries are made up of classes. And the rebalancing solution actually means a major redistribution of wealth in China, India and much of the global south away from the rich and towards the workforce.
I'd recommend you read the whole article.

My own submission to the G20 conference (via VoxEU) is going to be about ways to understand behaviour and encourage rationality - all of these imbalances somehow originate in cognitive biases of one kind or another. If we were fully rational beings, markets were perfect and information was fully available, crises would not happen.

Thus, to manage markets effectively we have to understand when and how people depart from this rational ideal. I have not yet come to a firm conclusion on the best ways to do this - some of it is about transparency, some is about having the right expertise in the regulator or macroeconomic institutions, and some is about mechanisms for automatic stabilisation.

Obama's two key points - regulation and stimulus - can both be examined through this lens.

Regulation is about ensuring that the rational interests of shareholders and taxpayers can be pursued and are not obscured by information barriers, limited liability and agency problems.

Stimulus is about closing a rationality gap in the macroeconomy by generating extra demand when the market doesn't move fast enough to do so.

If policymakers ask themselves one extra question when considering a problem or a solution, it would make a big difference to the effectiveness of their decisions. That question is this: are we relying on people to behave rationally, is that likely to happen, and what if they don't?

Tim Geithner's request also relates to rationality, but in a different way. What is rational for each individual country is different from what's rational for the world. A small country is, selfishly, better off freeloading off other people's stimulus than running its own. And in a world where even the US's share of global GDP is falling below 25%, we're all small countries now. But if every government acts rationally, everyone is worse off than if everyone acts rationally. The prisoner's dilemma, of course.

Coordination mechanisms are the only way to fix this problem. The US and China are big enough that it may be in their interest to stimulate unilaterally. This would also apply to the EU as a whole if it had a single fiscal policy - but of course it doesn't. It's no coincidence that the EU is the main rich-country block which is not currently implementing a major stimulus package.

The G20 may be a good coordinator itself, but this conference is a big inflection point for that. If nothing happens, it's unlikely that the G20 will have serious influence in future. If a stimulus is agreed, the G20 mechanism will grow in stature and will have much more moral influence in future policy setting.

Other institutions - the IMF, World Bank and WTO - work fine but they are constrained by having very specific aims. The theoretical world body, the UN, is completely irrelevant here - it has never occurred to anybody (that I've seen) to give it any kind of fiscal or even financial supervisory role.

There seems to be a vacuum at the top and until it's filled, world economic policy is going to be suboptimal. Even Davos didn't do much this year. Makes you wish the Bilderberg Group really was as powerful as the conspiracy theorists claim...

1 comment:

Wesley Fogel said...

What's the conclusion here??