- Over-enthusiastic community organisers
- A flawed response to China
- Business schools (along with 'misguided government programs, "only think for today" financially illiterate consumers, conflicted credit agencies, laughed at (and purposefully weakened) regulators, lobbyist groups running Congress, and many of our best and brightest in the corporate world')
- Barney Frank and Christopher Dodd
- The media
- The government
- The Internet
- Owners of imported cars
- David Bowie
- The Federal Reserve
- The free market
- Subprime borrowers
- Subprime lenders
- The head of programming of HGTV
Tuesday, 9 June 2009
Who's to blame for the financial crisis and the recession?
Rob Killick of UK After The Recession wrote an article last week explaining that "individual behaviour is not to blame for the recession".
This idea of 'who's to blame' is an omnipresent theme of the last six months. A quick search for "to blame for the crisis" or "to blame for the recession" makes hilarious reading. Here are the first few candidates that show up:
What is the appropriate response to this orgy of vilification? Is it to join in and give your own opinion of who's really to blame? Or is it to look at how the system works and try to draw some more reasoned conclusions?
Let me point to a few specific examples:
It's a tricky statement to evaluate, because it's either trivially false or obviously true - depending on how you interpret it.
Literally speaking, if the behaviour of individuals is not to blame, whose behaviour was it? The economy is not a machine run from outer space, it's the agglomeration of trillions of actions by billions of people. And everything that happens in it is, ultimately, traceable back to individual decisions by human beings.
But I guess what Rob means is that the structure of the economic system is one cause of the situation, and that political leaders shouldn't duck the need for changes by blaming a faceless mass of citizens. It's hard to argue with that.
It's a false dichotomy to claim that the only two options are "blame the individuals and carry on as before" or "reform the system". If the system needs reforming, it can only be done with an accurate understanding of human behaviour - avoiding the neoclassical fantasy of rational utility maximisation.
Another: Scott Sumner is convinced that the Federal Reserve is to blame for this recession (and, essentially, every other one). It's their fault for making money too tight (or allowing it to be).
And there are plenty more, as the above examples show.
But something feels a bit wrong about these attempts to pin blame on somebody. And not just the general moral queasiness of scapegoating.
One of the great things about markets is that they are - in theory - self-correcting. A market in equilibrium is a complex system where every part interacts with many others. Thus, every action involves more than one party. Subprime borrowers and lenders both enter into a transaction. Politicians and voters influence each other. Broadcasters and viewers reinforce each other's prejudices. Companies and employees set wages and conditions in an ongoing negotiation. The US government and Chinese central bank enter into a bond contract which suits both of them at the time it is struck.
So any action you might have taken which contributed to the crisis - taking out a subprime loan or lending money to the US government - was enabled by the party on the other side of the transaction. And implicitly influenced by every other person in the economy who has bought or sold anything else and thus affected the price you paid. The blame, if there is such, is diffused from you to everyone else in the economy.
And any overvaluing or undervaluing of a product, every innovation that is crowded out by overinvestment in housing stock, every person laid off by their employer will - in theory - be corrected immediately by arbitrage or repricing.
In this theory, a recession never happens. Any potential crisis is fixed by the system before it takes place, and nobody even notices that it was imminent.
Of course, this is not what happens in reality. Clearly the market does not immediately reach this kind of equilibrium - sticky prices and wages, or contracts, or adjustment costs, or high gross debt which cannot easily be unwound, slow the process and can cause major pain and a permanent loss of welfare. But what's "to blame" for the recession is not the action of any one individual, or any group. It's the overall behaviour of the system - which is nothing more than the aggregate behaviour of every person in the system.
Rob Killick characterises behavioural economics as "blaming individuals" and absolving everyone else (who else would that be, exactly?) But this is not at all the point. What behavioural economics does - like most other branches of economics - is to provide explanations of behaviour, and explanations of the consequences of behaviour, which can then be used to determine the appropriate solutions.
Maybe part of the solution is to do with US-China capital flows. Maybe it is to do with greater innovation in the private sector. Maybe it's to do with bankrupting or recapitalising the banks. But whatever it is, it was the choices of individuals that led to the problem and no solution can work without an understanding of how people make those choices.
And government probably does have a role in smoothing adjustments, combating market failure, putting a proper price on externalities and providing large-scale risk pooling and other coordination goods. Does this mean it's the government's fault if it doesn't get it all right first time?
We may as well stop blaming people: if economics is a science, its goal is to understand things as they are and provide tools to make them better. Don't try to shut down the process of understanding because the resulting tools aren't the ones you would wish them to be.