Knowing and Making

While the amount of net debt across the world is always zero , the amount of gross debt is not. And gross debt has reduced substantially in the last year as firms and consumers are deleveraging. An interesting post from Steve Waldman at Interfluidity praises this trend. I'm not convinced by his conclusion but he does contribute something rarely visible in economics commentary - a good philosophical understanding of what debt is. "Credit, also known as debt, is one of several arrangements by which a party with the power to command resources but lacking aptitude or interest in managing a productive enterprise delegates wealth to another party who is capable of creating value but unable to command sufficient resources." I would put it slightly more generally: Debt is a promise to give resources to another party in the future . On this view, the gross amount of debt in the world is a representation of the number of promises we have made to each other. A promise is a restrict...

This article is about how people lead people, but starts out with a more fundamental question: Why do people lead people? Indeed why do leaders exist? To answer this we must go further back and ask why there are even any groups of people to be led. The simple answer is that is what works. Specialisation of roles emerged long before Henry Ford and Adam Smith - as soon as hunter-gatherers settled in villages and discovered agriculture, there were some people out in the fields digging, some people making tools or clothes, some raising children and others inventing the wheel. Specialised roles are more efficient because people have different talents and, with practice, can get good at one thing. They can use the tools appropriate to the job and stay in one place to carry it out. And when you have specialised roles, you need a team. Whoever is making the clothes still needs food to eat, and if they are not growing it themselves they must cooperate with someone who is. So groups of cooperati...

We need certainty about the future in order to do anything. It’s a basic requirement of the action-feedback cycle that intelligent beings use to achieve their goals. On the simplest level, if I want to pick up an apple to eat, I need to know that when I tense my arm muscles, my hand will move in such a way, and when I grip it and pick it up, it will weigh (more or less) how much I expect, so that I need to apply just this much pressure to bring it to my mouth. I need to know that it will be this hard to bite and that it will give me some energy and assuage my hunger. If I am missing any of this information it’s highly unlikely I’ll be able, or even want to try, to pick up and eat the apple. In a more sophisticated decision I need the same predictability. I have to know that when I hire this person, they’ll show up at work, and when I sign this contract, the customer will pay the money on time, and when I build this car, someone will buy it. If we have certainty, it lets us see clearly ...

If the leveraged financial structures supporting the operations of the world economy are unravelling, what will happen? In the short term, it's dangerous. Today, according to the FT , banks are refusing to lend to each other. Soon that will start to have knock-on effects for exporters, and soon after that for domestic business too. They can't borrow money because their banks' risk models require the loan to be laid off to other parties who will no longer play. So companies won't be able to get export finance, and won't be able to take on domestic projects that require financing either. Why is that? If the money is out there but the banks won't lend to each other, people who need it are going to have to start finding new financial suppliers. Let's say that bank A has a strength in lending foreign exchange to manufacturers, and usually finances this by swaps with banks B and C in the forex markets. The money is spent by the manufacturers and comes back into th...

Should we spend so much money on sport? Hilariously, now that the Olympics have started and nobody can have the conversation about how badly Britain will do, a new topic arises: are we too good at cycling ? This question is sometimes framed like this: are we spending too much money on something as trivial as sport ? And sometimes it is more like: should we be doing better in 'real' sports such as athletics instead of in sports that "young African men can't afford to play"? Either way, those who choose to spend money on training elite sportspeople are rightly asked to justify it. Perhaps the standard answers are valid: Olympic success encourages other people to take up sports - improving quality of life and reducing healthcare expenditure long-term. The Olympics in London will encourage tourism and that will generate more money for the economy than they will cost. But whether consciously acknowledged by the funders or not, there's another reason why this succes...

Another area of theory I have been working on in the last few weeks is pricing. It's well-known that suppliers can use price discrimination to distinguish between those customers who can or will pay more, and those who can't. Here are some (edited) notes from a forthcoming report we are publishing about the concept of structured pricing. Economic theory relies on agents trading products and services in a way that makes all of them better off. Any two people entering into a transaction should both gain from it; whatever is traded must be worth more to the buyer than the money they pay; and the money must be worth more to the seller than the object they’re selling. Any trade therefore provides higher value to both parties than they currently have – or else it will not happen. In classical economics, the price of something is regarded as a signal to tell the buyer and seller how much other people (at the margin where the supply and demand curve intersect) value it, and therefore ...

The motivation principle : People act in their best interest, in the light of the information available to them, over a time period that they can accurately foresee. The first two of these statements seem relatively obvious but perhaps the third is not so clear. It means that people will not take an action today, for some nebulous potential benefit one day in the future. They must gain something in return for the action either immediately, or within a time horizon that they can clearly grasp. How long is that? If I make a calm and considered decision, the time horizon may be as much as a few hours; while in the heat of the moment it may only be a few seconds. Either way, in order to act in my longer-term interest, I must get some kind of short-term payoff or else it's too easy to sell out on my decision. For example, if I want to lose ten pounds and be able to run a marathon in six months, I won't succeed unless I give myself incentives that keep paying off for all those early ...