Wednesday, 10 March 2010

Osborne's new economic model?

The Conservatives apparently think a "new economic model" is needed to restore the strength of the British economy.

I wonder what they mean.

I assume they aren't talking about a model in the way an economist would think of it: a simplified representation of the operations of the economy. Probably they mean "we need to run the economy in a different way". This is how businesses use the word "model" when they talk about choosing a business model, or a revenue model. So maybe he just wants to use a different set of rules for taxes, employment or general economic incentives. This speech gives some clues - it's tricky to read through the rhetoric to find any common underlying model, but what he seems to want is to set three "priorities" for government economic policy.

But taking him literally reveals a more interesting way to think about the question. What if he really does want to change the descriptive model that we use to think about the economy?

In principle, a model should be a neutral description of a complex system, and the fact that different models exist shouldn't affect the behaviour of the system itself. Choosing a new model is usually an attempt to incrementally improve the fit of your model with the real world - not the stuff of political revolution.

But interesting things happen when a model turns out to be accurate - or if people think it's accurate. People start to use it. People making decisions about the economy use the model to decide what to do. And the more accurate it seems to be, the more likely they are to use it.

So by developing the original General Theory model of economic activity, savings and unemployment, Keynes had a vast impact on the decisions made by governments and, in turn, by individuals responding to governments.

Successive monetary models have influenced how central banks controlled interest rates (exchange rate models, money supply models, NAIRU and the Taylor rule).

And models of the finance markets have influenced how banks and regulators have interacted with each other within the finance markets.

What if these models are wrong? Are people making vast, sub-optimal decisions and hurting billions of people because of a broken model? Probably. The choice of model does matter.

All of the models I've just mentioned have something in common: they influence the actions of a small number of big players. You could argue that at the lowest level, models don't matter so much - people act according to their local incentives and if they behave according to an inaccurate model, their mistakes will cancel each other out through the forces of competition or evolution. The model's aim is to describe microbehaviour, not influence it.

But actually, people do still follow a mental model in their decision-making, and many of these models are pervasive enough to have a macroeconomic impact. Some examples of models which (I'd suggest) most economic actors are following:

  • Money mostly has an objective value
  • Savings are good, debt bad
  • Investment is good too. That's just the same as savings, right?
  • We don't need to save too much, because our risks are cushioned by spreading them across the population
  • Financial institutions are safe
  • If my job was there this month, it will probably be there next month
People who didn't follow these mental models would behave very differently, which would make a real impact on everyone else.

So at high and low level, the "economic models" that we follow do have real consequences. If we could change some of those models, the economy would probably be transformed. Therefore perhaps George Osborne does intend to change them. If so, to what?

I hear he likes behavioural economics - so perhaps he has a behavioural or cognitive economic model in mind. His speeches suggest he wants to cut public borrowing and spending - so perhaps he believes in a model in which high borrowing slows economic growth or damages incentives. He says he favours lower personal debt and higher investment - so perhaps his model says that high debt and low investment have negative outcomes.

Whatever his new economic model is, I'm sure he will tell us in more detail at some point.

But change is hard, especially changing other people's minds. Do you think he will be able to change the economic models used by public policymakers? By civil servants? By private companies? By the general public? It would certainly be an interesting project to try. But I'm not sure that a politician is the one to do it - and if anything, Osborne's speeches seem designed to be consistent with the public's existing mental models, not to alter them.

Look instead for academic economists whose ideas Osborne will promote; this is a much likelier route to changing opinion. Here are some of his key advisers. None is an academic - they mostly worked for think tanks and banks. One who has worked at a university is Alan Budd, tipped as head of the Tories' Office for Budgetary Responsibility - who seems fairly mainstream in his economic views. But apart from Budd, it's hard to tell what model someone is likely to believe in if they don't have a record of published work.

So Osborne's new economic model - for all that it might genuinely change the path of the UK economy - remains a bit of a mystery. I look forward to finding out - before the election - what it will be.

p.s. having drafted most of this post, I typed "George Osborne" into the address bar of Google Chrome. The first [and only] autocomplete link it showed me: Google owns Blogger, and my draft was in the adjacent tab of Chrome. Is this extreme cleverness, supreme coincidence or just rather spooky?

p.p.s. it was none of the above. Turns out I bookmarked the speech nine months ago intending to write about it, and forgot!

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