Saturday, 18 July 2009

Some thoughts provoked by a few blogs

Some of these articles have been lingering in my spare browser tabs for weeks, so it's time to link to them and explore a few thoughts that they have stimulated.

Chris Dillow asks if economics is like Feynman's onion. It's a good analogy. People, much more than physical particles, are complex. This isn't to say we can't build models of how they behave: we can and should. And while there are lots of people decrying the state of economics (having been given permission to do so again this week by The Economist), those who think model-building is a bankrupt approach are wrong.

Model-building is the essential activity of economics and perhaps its greatest contribution to the social sciences. Indeed this is why it is to similar with physics: the best physicists know, as Feynman did, that they are not looking for an ultimate answer and even if they found one, they wouldn't know it. All we can ever seek is a model that describes the world well, and keep testing it to make it break.

Economists likewise have a neoclassical model which provides some approximation at a description of human behaviour; it clearly has holes in it and those holes need to be eliminated. They can be patched up with the economic equivalent of epicycles - sticky wages, say, or a bit of endowment effect. But every so often the whole model should be replaced with something new, incorporating the best of the previous one but going beyond it. This is where I believe behavioural economics needs to go: not, as Chris points out, under the illusion that they are discovering the economic theory of everything, but with the ambition to provide the next generation of unifying model. No doubt in another fifty years it will be replaced again, but if we have a few decades of better economic predictions, greater wealth and welfare, and reduced poverty to show for it, it will have been as noble a cause as one could imagine.

And so, if you hear anyone say that economists' obsession with mathematical models caused the financial crisis, this is little better than saying that physicists' obsession with the mathematical laws of motion caused that bullet to hit JFK. The question isn't whether models should be used, it's how to make better ones and apply them in the most effective way.

As an aside, I'm believing more and more that we shouldn't call this field behavioural economics but cognitive economics: behaviour is just the outward manifestation of the phenomena we want to analyse, which are about how people think and how they value things.

One of the things they value highly are cultural products. Razia Iqbal, the BBC's culture editor, asks whether the creative industries can provide new business models which flourish in "the current economic climate"*. The cultural sector is expected to grow at a rate of 4% over the next few years, according to NESTA.

While there are always problems of defining the cultural or creative sector - at one point we applied for a venture capital mentoring programme and were allowed in on the basis that software is creative, while another funding application focused around software and applications of game-playing was turned down for not being creative enough - I have little reason to doubt this projection. The cultural sector should, at the least, gain in importance relative to manufacturing and other industries as a developed economy continues to mature.

But this isn't the most interesting area. The exciting potential is for what the cultural sector can do for the rest of the economy. Different types of business are not indepent, mutually exclusive activities: instead they interact in a complex way. The automotive sector is strengthened by the contribution of the creative sector to its marketing and design processes; the music industry is boosted by the availability of new hardware on which to play songs; the property sector was enriched (albeit temporarily) by the evolution of the financial markets; and the aviation and engineering industries grew because of the mining sector's development of cheap oil sources, then returned the favour by providing the technology for miners to explore undersea and other remote sources of minerals.

The development of these links and relationships is at the heart of economic growth and I expect a major driver of the next decade's growth to be the application of cultural ideas and outputs to other types of product.

Few physical products stand alone any more; the value of most of them, at least in the rich economies, is a function of the subjective values that surround them. These include branding, aesthetics, social reinforcement, relative status, the stories that products evoke, the futures they allow us to imagine, and the moral content of the products. All of these factors contribute immensely to how we value the products we use, often as much or more than their material functionality.

The cultural sector, with its insights into human motivation and perception, has the potential to be in the coming decades what finance was for those just gone. It will be the enabler of a transformation in the value and output of every other part of the economy.

Incidentally, this cross-fertilisation between different industries is why arguments like this one from Rob Killick are erroneous. He complains about "innovative investment products" as if investment has no impact on the rest of the economy. But in fact, innovative investment products such as the limited liability company, the life insurance policy and the mortgage have enabled people to create productive companies, provide for themselves and their families and house themselves. While there is less low-hanging fruit now, there are still new investment concepts to be invented which will let the economy work better, use human time and capital more efficiently to make more stuff, and help that stuff to be better personalised - using cultural products - so that it makes consumers happier.

No doubt there are some products which are not so useful - Rob rightly suggests that financial engineering to get around the 50% tax rate is not a very good use of anyone's brain - but this shouldn't be used to condemn the whole finance sector as a parasite.

This is closely linked to the idea that the British economy should be based more on manufacturing and less on services (particularly financial and business services, which are intermediate factors of production and not for direct consumer benefit). But Stephanie Flanders points out that this greater reliance on manufacturing hasn't protected the German economy in the recession: indeed, German GDP has shrunk much more than has the UK this year. There's a respectable argument that services are achieving exactly what they're meant to - and exactly what financial products are meant to do - which is to provide cushioning against volatility. Manufacturing demand is inevitably more volatile because products are more commoditised, relatively fungible and easy to run up and down stocks. To the degree that they are embedded in culturally determined services, this volatility is reduced; and the service providers themselves are much more stable than product businesses. I'm quite relieved not to be selling yachts right now.

If any of you have read Tyler Cowen's Create Your Own Economy yet, you may recognise hints of some of these arguments. And if you have read Chris Anderson's Free (which I haven't, so far) I suspect some of the discussions of cultural products are relevant to that too. I have articles coming up on both of these books so more on that soon.

* this phrase is so overworn now that in some circles it can only be spoken sarcastically. Note that there are over 1.1 million results for it on Google. Possibly the best of which is an advert recommending you to "Find the Best Results for Current Economic Climate!" on a different search engine.

2 comments:

Ravi said...

Hi, at competitivemarket.blogspot.com there are a few recent posts, the author is a poli sci grad I believe attended a poli school however, he asks a few question using theories about rights, educations, inflation, and banking, and also whether we need more unemployment insurance,

Runako Mowatt said...

Hi, I've recently discovered your blog and its a good read. I was drawn in by the economic analysis of Arsenal and their business model. I wonder if you have an update, considering the recent transfer news :)

I have 3 questions:

1) Where do you find the time to write your blogs with such regularity;

2) Do you have any thoughts on the procession of pre-pack administration sales occuring at the moment;

3) As i have a (simple) blog of my own, i am looking to link to interesting sites. Would you be interested in doing so?

After all, in the "current economic climate" one my try to diversify.