Panglossian finance

Disagreement among practitioners of the dismal science

As David Blanchflower argued in his first economics column for the NS, the crash of autumn 2008 wasn't just a failure of banking practice -- it was an intellectual failure, too. The collapse of Lehman Brothers just over a year ago wasn't just an indictment of hubris and greed on Wall Street; it was also "a body blow to those economists around the world who had designed worthless mathematical models, based on unrealistic assumptions that they then used to convince themselves that a recession of this kind could never happen again".

Blanchflower's magisterial dismissal of "useless economic models" echoed something the Nobel Prize-winning economist and New York Times columnist Paul Krugman had a written a couple of weeks earlier. Under the title "How Did Economists Get It So Wrong", Krugman chastised economists for "mistaking beauty for truth" -- for allowing themselves, that is, to be seduced by abstract mathematical models and an "idealised vision of an economy in which rational individuals interact in perfect markets". The only problem is that perfect markets have never existed and never will exist -- pace what Krugman nicely calls "Panglossian finance" -- and the sooner economists "learn to live with messiness", the better.

That's a very Keynesian view, of course. As Peter Clarke shows in his book Keynes: the 20th Century's Most Influential Economist (reviewed in the NS by Andrew Gamble), a recognition of the pervasiveness of uncertainty was a very important part of Keynes's vision. Keynes wrote that the "fact that our knowledge of the future is fluctuating, vague and uncertain, renders wealth a peculiarly unsuitable subject for the methods of the classical political economy". In other words, the market doesn't always get it right; in fact, very often it gets it catastrophically wrong.

Compelling stuff -- but some of Krugman's fellow economists have objected to being handed such low marks, among them John H Cochrane of the University of Chicago, who returned fire in an article entitled "How Did Paul Krugman Get It So Wrong?". Cochrane boils Krugman's piece down to the thesis that (in Krugman's own words) "Keynesian economics remains the best framework we have". He then charges Krugman with making a number of incompatible arguments.

For instance, in Cochrane's view, it is only because Krugman caricatures the so-called "efficient markets hypothesis" that his call for an economics that "recognises flaws and frictions" and "incorporates alternative assumptions about behaviour" has any force at all. Cochrane is caustic about this:

I say, "Hello, Paul, where have you been for the last 30 years?" Macroeconomists have not spent 30 years admiring the eternal verities of Kydland and Prescott's 1982 paper. Pretty much all we have been doing for 30 years is introducing flaws, frictions and new behaviours, especially new models of attitudes to risk, and comparing the resulting models, quantitatively, to data. The long literature on financial crises and banking which Krugman does not mention has also been doing exactly the same.

Further, according to Cochrane, "Krugman argues that 'a more or less Keynesian view is the only plausible game in town', and 'Keynesian economics remains the best framework we have for making sense of recessions and depressions'. One thing is pretty clear by now, that when economics incorporates flaws and frictions, the result will not be to rehabilitate an 80-year-old book." Ouch! Cochrane goes on: "A science that moves forward almost never ends up back where it started. Einstein revises Newton, but does not send you back to Aristotle. At best you can play the fun game of hunting for inspirational quotes, but that doesn't mean that you could have known the same thing by just reading Keynes once more."

Cochrane is taking it for granted here that economics is a science, in the way that physics is -- that's the point of the gibe about Einstein, Newton and Aristotle. And I think that may be where the disagreement between Krugman and Cochrane is most profound. For, as Krugman surely knows, Keynes regarded economics as being a moral as much as a mathematical science. This is one of the central insights of Robert Skidelsky's recent book about Keynes, also discussed in the review by Andrew Gamble mentioned above: "One of the greatest defects of economics today is that it has become a branch of applied mathematics. [But] Keynes thought of economics as part of the human discourse."

Jonathan Derbyshire is Managing Editor of Prospect. He was formerly Culture Editor of the New Statesman.

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Politicians and fashion? Why their approach can be telling

My week, from spying on the spies to Theresa May’s fashion charm offensive – and how Sadiq stole hearts.

About nine months ago I was asked if I wanted to spend a morning with Zac Goldsmith, as he appeared to be wakening from the slumber that had obviously taken hold of him when he decided to run for mayor of London. However, after about three minutes in his company (maybe less, actually) I realised that not even his campaign team – let alone voters in the Borough of Southwark – thought he had a hope in hell of winning.

There was only ever going to be one winner, and the enthusiasm with which Sadiq Khan has been greeted by London has been heartwarming. He won the politician award at GQ’s Men of the Year Awards a few weeks ago, and I’d never heard such a roar as he leapt up on stage to collect it. Well, I’ve heard such roars for the likes of Michael Caine, Elton John and Amy Schumer, but rarely for a politician. In fact, the last time there was such fulsome applause for a politician at the GQ awards was when we gave one to a pre-Sextator David Blunkett. Perhaps I shouldn’t be surprised: the last time Noel Gallagher graced us with his presence, he asked: “Is this what a Conservative party conference looks like?”

 

On the dole

The recent past is being hauled over so repeatedly that soon there are going to be ­retrospectives of events that happened only last week. Or next week. On paper, the new exhibition at the V&A in London, entitled “You Say You Want a Revolution? Records and Rebels 1966-1970”, seemed slightly behind the curve, but the reality is very different – as it’s probably the best exhibition you’ll see in London this year.

This is all down to the curation, which was handled by Geoffrey Marsh and Victoria Broackes, the wizards behind “David Bowie Is”, the most successful show in the V&A’s history. It’s a terrific exhibition, although being reminded of the cultural and political insurrection of the Sixties also reminds you of the period’s seemingly innate optimism as a new London was mushrooming into life. Winston Churchill was dead, abortion was about to be made legal and the rise in happiness seemed exponential. Britain was experiencing almost full employment (though the government wobbled slightly in the spring of 1966 when it was announced that the jobless total had gone up to half a million). It never occurred to anyone that there might not be a job
waiting for them when they left school or their red-brick university.

 

Priced out

There certainly won’t be a house waiting for them, not if they intend to live in London. The marketing bods behind the new development at Battersea Power Station came in to make a presentation at Vogue House a few weeks ago, showing us lots of slides and videos about their fabulous ­development. There’s a Frank Gehry this and a Frank Gehry that, a swimming pool, a private members’ club and lots of artisanal independent retailers selling organic rhubarb and fancy beer, blah blah blah.

Their roll-call of “good things” included the ominous words “affordable housing”, but this appears to be anything but. After the presentation, I promptly stuck my hand up and asked them what they actually meant by affordable housing. The answer I got wasn’t satisfactory, so I asked again: “What does your entry-level accommodation cost?” And the very charming man with the lapel-mike coughed apologetically and almost whispered, “£350,000.” At which point I made my excuses and left.

The idea that my daughters can one day get on the property ladder in London is pure fantasy, and they certainly won’t be living in Battersea, or indeed anywhere near it.

 

Back in fashion

Last Thursday, Theresa May hosted her first reception at Downing Street for the British fashion industry, an event that usually takes place twice a year, and which is attended by fashion designers, industry figures, newspaper and magazine editors and the like. ­Samantha Cameron was always a significant supporter of the sector (which contributes more to the country’s GDP than the car industry), as was Sarah Brown before her, and it is instructive that May has decided to follow in their footsteps.

It’s also telling that Mrs Cameron was not only invited to the event at No 10 but turned up, which says a lot about both women. Theresa May is a fundamentally shy person, yet she not only made a pitch-perfect speech in front of a Brexit-sensitive (and quite possibly suspicious) crowd, but chose to embrace the opportunity to espouse the growing importance of an industry that was so closely associated with the wife of her predecessor. There is such a lot of noise at the moment surrounding the PM’s apparent lack of interest in remaining on good terms with David Cameron, so one wonders what, if anything, is going on here. Taken at face value, May’s move at the reception was extremely classy.

 

The spying game

The following day I found myself in Cheltenham for a five-hour briefing on counterterrorism, cyber-defence, drug smuggling and child kidnapping at GCHQ.

I had expected the place to be like the Foreign Office, but it’s actually more like Google, Apple or Nike, and feels as though it could easily be a campus on America’s “Left Coast”.

There is an incredible sense of purpose at GCHQ, a feeling that they are all working for the common good, and frankly I found it infectious. While the denizens of Silicon Valley might be very adept at pushing the frontiers of consumerism, designing training shoes, telephones and algorithms, it felt far more appropriate to be spending time with men and women obsessed with making the world safer.

Dylan Jones is the editor-in-chief of GQ and a trustee of the Hay Festival

This article first appeared in the 22 September 2016 issue of the New Statesman, The New Times