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"Maybe I need an economist to tell me that" Samuel Brittan: Remarks to St Andrews Liberty Club 13/10/03 Introduction Academic economics, which includes much of the economics produced and consumed by finance ministries and central banks, has not had a good press in recent years. It is sometimes accused of being too left wing or being too right wing or for being just wrong in the predictions its practitioners are tempted into making. It is also accused of being excessively mathematical or not scientific enough. But I have always been bothered by a much more basic criticism which was made to me in no uncertain terms by a veteran Labour Party leader of years gone by, one Emmanuel Shinwell. (His nearest equivalent today would be John Prescott, the deputy prime minister.) I had the good or bad fortune to have to meet Shinwell at Cambridge railway station when he came to address some students. He asked me what subject I was reading and snorted when I told him. He very soon launched into a series of questions about current problems, responding to each answer with "I did not need an economist to tell me that". The market place evidently agrees with Shinwell. You only have to go into any half serious bookshop to see masses of books on popular science and, nowadays, on history. Nothing of this kind exists in economics, where you only see business guides tempered by the occasional polemic against globalised capitalism. You may find on some very low shelf some economic text books which have been prescribed for examinations. At the risk of being accused of arguing with the market, I am going to suggest there are a few worthwhile economic ideas. For those of you who are studying the subject, please regard it as an exercise in trying to discern the shape of the wood which risks being obscured by the trees. For those of you who are not, I want to extract a few ideas which might be helpful to you either as citizens or as students of politics, modern history or even political philosophy. What I cannot do is to tell you how to invest on the stock exchange, how to be a master business executive or to become rich in any other way. Unlike your academic instructors, I do not have the luxury of spreading my ideas over a whole course of lectures;, and I shall have to cover a lot of ground very quickly. But please do not bother to take any notes unless you find note-taking relaxing or an aid to concentration. In any case this talk, including the parts I may not have time to deliver, will soon be on my personal web site, together with appropriate references. Like the Roman province of Gaul my talk will be divided into three unequal parts. First I will highlight a few economic ideas on which mainstream practitioners ought to agree, but the ignorance of which generates fallacies that you hear in almost every political speech or business or trade union address. Secondly I will mention a few ideas which the economics profession itself might benefit from taking more seriously. Thirdly, and briefly, I will finish with a thought or two of my own. Common Fallacies There are erroneous beliefs that are often regarded as common sense but which are really self serving convictions, which I sometimes dignify by the name of businessmen's economics. But before we can nail the fallacies I have to bore you with two basic principles which, despite what Shinwell said, it might need an economist to point out. The first is comparative advantage in international trade. Most people can see that if one country is more efficient at producing steel and another at producing bananas it pays to specialise and exchange. What not one person in a hundred appreciates is that it may still pay to trade even if one country is more efficient at making both steel and bananas, say because it has a highly developed hot house industry. If the US can produce both bananas and steel at lower cost than Brazil it pays for the two countries to trade with each other, so long as the USA has a greater advantage in steel than it has in bananas. This is fundamentally a mathematical proposition, although mathematicians who have not dabbled in economic theory often find it very difficult to perceive. It was first developed by 200 years ago by the British stockbroker turned economist and MP, David Ricardo. He was a mathematician by temperament but not by training and had to develop it through mind numbing examples of exchanges between bales of cotton and bales of wheat. His proposition is nevertheless as near incontrovertible as anything can be in this area. One source of confusion has been that economists have tried to move beyond this general principle and tried to predict, mostly unsuccessfully, which countries will specialise in which products. It nevertheless remains true that countries of very different levels of development and efficiency can still trade profitably. The second key idea is somewhat more difficult to put across. It is the circular flow of income. This is something that most macro-economists regard as too obvious to stress. If they were to listen to their favourite taxi driver, they would see how far being taken for granted it really is. The basic thought is that there is a continuous flow of spending between customers who desire to buy products, the incomes received from supplying their wants and still further purchases. The ignorance of this flow is probably the most important single force of perverse economic policies today. For instance it is assumed that if Britain loses arms orders in pursuit of an ethical foreign policy that the workers in the arms industries will simply waste away in idleness. It is not asked whether there will be other purchasers at home or abroad to make up the difference. To take another example: many alarmist writers wonder what will happen when China and India are able to produce cheaply vast quantities of products which are now made in the West. But few people go on to ask what the Chinese and Indians will do with their export earnings. Presumably they are selling these cheap goods to make a living and not to line their bank vaults with sterling, dollar or euro notes. Even if they are so misconceived as to do so, the circular flow could still take place; but this is something to be explained after a few stiff drinks or with a cold towel round our heads. The complication, best admitted at the outset, is that the circular flow of income can be helped by sensible policies, such as efforts to maintain an adequate but not excessive flow of total spending. The contributions of both Keynes and Friedman are both relevant here. Great depressions and runaway inflations need not be, and indeed are not, a normal feature of market economies. If we can hold on to these two ideas - comparative advantage and the circular flow of income - we can immediately nail some very common fallacies. You will find them exposed in more detail in Innocence and Design by David Henderson published by Blackwell in 1986. The first and astonishingly frequent example is structure snobbery. This is the belief that certain sectors of the economy such as manufacturing are inherently superior and that other service sectors - usually vilified as hamburger stands or Chinese laundries - are inherently superior. Another example is the cult of competitiveness in ministerial and business speeches. Competitiveness applies to individuals or companies, not to nations. Perhaps the best way to see this is to realise that not every country can be more competitive against every other. Against whom should the world be more competitive? The Moon? Or Mars? The tiny vestige of truth in this kind of talk applies only if a country has an overvalued exchange rate. Nearly all so-called competitiveness problems arise from misconceived attempts to peg a country's exchange rate. When Britain was foolish enough to peg its exchange rate at $4 to the £, then it did indeed seem difficult to sell enough goods or attract enough capital to pay our way in the world. [The remedy - which was originally seen as political defeat was first Harold Wilson's initial devaluation of the pound in 1967 and then the move to a floating exchange rate by the Heath Conservative government in 1971.] A third misleading slogan is convergence. This arises especially in relation to the European Monetary Union. As a pragmatic matter I am not in favour of Britain adopting the euro in the foreseeable future. But if some government did contemplate joining, the only convergence that would matter would be that of the nominal interest rate required in the UK and in the members of the eurozone ("One size fits all"). Unfortunately many of the people who I call the Great and the Good also want convergence in real performance - in output, employment and productivity. The worst examples of this is the British espousal of the level playing field. This may be a natural cliche for a spokesman with what (the British call) a public school background; but it is in danger of ruling out all the conditions under which international or inter-regional trade can takes place. In my experience no amount of academic training can prevent people from uttering these fallacies if it pays them to do so. One problem about driving them out is that there is no fallacy or piece of special pleading which some distinguished economist has not advanced at some time or another. There is also a more important reason. Suppose for instance you are an economist at the British Department of Trade and Industry. Ministers from all the main political parties insist that the UK "must be more competitive". Such an economist may nevertheless think that the UK, like any other country, can improve its performance; and he or she tries to massage the word competitiveness into meaning better performance. The harm arises if they gradually begin to believe their own phraseology; or if they mislead the readers of government White Papers. There is a related fallacy to which I want to draw particular attention. This is the whole concept of national export drives. We have in Britain the Export Credits Guarantee department which makes available finance on advantageous terms; tax-funded exhibitions to promote British goods, royal visits to dubious regimes, receptions for unpleasant dictators at Buckingham Palace, the more innocuous-seeming Queen's Award for Exports and many other activities. I would scrap the lot. The reason for my emphasis is the contradiction between the British government's claims that it is pursuing a foreign policy with an ethical dimension - and, as we now know from Tony Blair, "no reverse gear" - and the very strong official involvement in promoting arms sales. The argument is not against all arms sales. Indeed it would be beneficial to have more specialisation rather than less among Nato allies. The argument is against giving the benefit of the doubt to sales to countries which are dubious, either because they may turn against us or because the arms support internal tyranny and violations of human rights. It is very difficult to believe that some of these arms have not ended up being used against British troops in one or other of the recent "ethical" interventions. British equipment was used by Iraqi troops in the first Gulf War of 1991. Fears that French troops would face forces using their own equipment may well have contributed to the French decision to oppose the second Iraq War of 2003. Orders of magnitude do matter here. If a country's economy is highly dependent on the one kind of export - for instance Hong Kong on textiles in the 1950s, or Brazil on coffee in the interwar years - then any abrupt drying up of the market in question would inflict a serious adjustment cost. Such considerations do not apply to UK arms sales. There was a high-powered investigation involving Ministry of Defence economists, which concluded that "defence exports" accounted for 0.4 pc of total employment. A 50 per cent cut would, it estimated, lead to the loss of 49,000 jobs in that sector, offset by the creation of nearly 67,000 new jobs over five years. The relocation might affect two or three key constituencies but less so than many other structural changes in the past. Yet when the Ministry of Defence saw which way the wind was blowing, the report of this inquiry lost its official status and became instead a University of York research paper. (The Economic Costs and Benefits of UK Defence Exports, Centre for Defence Economics, York 2001). Since then the Ministry of Defence has even more emphatically come out in support of the British arms industry, the latest example being the controversial exhibition in London's Docklands where many of the potential buyers who turned up did not belong by any stretch of the imagination to potential allies. What they might not teach you What I have said so far is or ought to be the common property of mainstream economists, even though they may not choose to emphasise it for reasons I have hinted at. But I now want to move on very briefly to a few aspects which all too many British, and perhaps eastern seaboard American, economists do not take on board sufficiently. There was a famous book entitled What they did not teach you at the Harvard Business School. I cannot claim to know exactly what is taught at St Andrews or elsewhere. But I still suspect that there are some recent developments that do not receive the emphasis they should. I find it striking that so many of the people who come to talk to me about recent economic events or government policy come from faculties of politics and modern history. At the end of the day it does not really matter from which faculty academics come so long as their work is enlightening. But in my experience professors of politics, international relations, sociology or political philosophy do not - with a few distinguished exceptions - deal well with economic issues, irrespective of their political views. The content of the most widely used economic textbooks is often called in academic circles "the neoclassical Keynesian synthesis"; but I have been warned by university friends that most students regards this as simply "economics" and I have to explain that there are other varieties of the subject. My own view is that this synthesis is fine as far as it goes and needs to be taught, even if different authors put different emphasis on the neoclassical and Keynesian parts of the synthesis. But all the varieties leave out important matters. More years ago that I like to think, I made a list of what were then new developments in economics which were hardly known to many British practitioners (Participation without Politics, Institute of Economic Affairs, First edition 1975, last published 1979). Some textbooks now mention them, but they still receive too little emphasis. The application of the theory of competition to the political market and to the struggle for votes and power. This is now known as Public Choice. The point is that much thinking on economic policy is rendered worse than useless by a sharp contrast between the faults of real world government and the actions of some non-existing and improbably, ideal, benevolent and omniscient government. Some of these ideas are now to be found in courses on politics, but nowhere are they given enough emphasis. Let me give a few very quick examples. There is a difficulty in defining what we mean by the majority view. This is an ambiguous concept if there are more than two alternative policies. A decision taken, for instance, by a committee can depend on the accident of the order in which amendments are considered. These difficulties are compounded by the complex policy bundles between which voters are supposed to choose at elections according to democratic theory. Of course they do no such thing. There are also the incentives within the bureaucratic process. The chain which links voters' preferences with the day to day behaviour of the individual official is long and has many weak links. On the other hand close connections inevitably develop between the regulating agency and those whom it is supposed to regulate - a notorious example being ministers responsible for agriculture and the farming lobbies. The Ministry of Defence sometimes looks like a branch office of British Aerospace Systems. Yet another weakness is the lack of incentive for the ordinary citizen to become even moderately informed on major issues. In their private lives people know about the cash constraint as an influence for rationality. Indeed, from the point of view of self interest it does not pay to vote as the chances of one's own vote deciding the outcome are millions to one against. Some political and economic theorists have made too heavy weather of what they call the paradox of voting. Slightly more than half the electorate still vote, either out of a sense of duty or to express their feelings. But you only have to see how the turnout drops if there is a major football match or a popular television programme to see that the voting paradox does matter. Another long neglected area is the analysis of property rights and the effects of alternative allocations on the use of resources. We all have our own views on how or whether distribution of property rights can be improved. But it is not property rights, but their absence, which is antisocial. It is because no one owns pleasant vistas or the ocean bed that market disciplines do not apply and that governments have to go in for clumsy attempts at direct regulation such as the EU Common Fisheries policy. Some limited progress has however been made. The Iceland government auctions fishing rights at least for the domestic fishing industry. The British government among others, has introduced the idea of transferable pollution permits, which exchange at a market price. A third such area is the economics of benevolence and charity. This has been made specially topical by Gordon Brown's big extension of tax relief and other incentives to private benevolence. I think he is right to do so because of the free rider problem. This means that people may give less to charity than they would be otherwise willing to do if they knew that others would follow suit. One benefit of this whole discussion is that it brings home to people in a way that no abstract argument can the difference between self-interest - which can encompass many objectives - and pure selfishness which market economists are always accused of promoting. As I am told that both property rights and the economics of benevolence are now becoming part of the mainstream, I will now move onto the fourth and in my view most interesting development. This has been the emergence development of political and moral philosophies with the conscious aim of throwing light on questions such as the just distribution of property rights, the legitimacy of coercion by democratically elected governments, the appropriate extent of state power and much else. Those of you interested in political philosophy will probably find these matters discussed under the heading of "Rawls and Nozick", who were the best known (and recently deceased) American pioneers of such discussions, although there are many other contributors. You cannot make a thoughtful contribution to economic policy without at least a nodding acquaintance with this kind of discussion. My own personal view is that it is the methods employed by such writers which are important rather than their specific policy conclusions, which are highly suspect. There is the analysis of markets as a discovery procedure in a world where tastes and techniques are changing. The emphasis on the role of markets and prices as a discovery mechanism is often known as The Austrian Contribution. This is because the pioneering studies were made by economists of Austrian origin, most of whom eventually made their homes in America or Britain. It has nowadays not all that much to do with the Alpine republic known as Austria. "Austrian" economists are mostly to be found in New York and a few other American centres. At least the retention of the label Austrian helps to remind us that Adolf Hitler was not Austria's only contribution to the modern world! Friedrich Hayek, who pioneered this approach in the late 1930s, regarded information as scarce and expensive. Were he writing today he might have to rephrase the matter. For it is a cliche that we are living in the information age and that we are suffering from an information overload. One reformulation is the need for a procedure for extracting information relevant to decisions on which we cannot rely just on computers. Another formulation, which appeals to me, is the distinction between information and knowledge. Within the category of knowledge there is a distinction between knowing how and knowing that. (See Gilbert Ryle, The Concept of Mind). The point of the "Austrian" critique is the need to study the operation of markets as a system for tackling, however imperfectly, the interactions between human beings. This has been made much more concrete with the fall of the Iron Curtain and the disappointing experience that Russia and some other communist countries have had in rebuilding their economies. The point that many Western advisers missed was that it was not enough to remove controls on prices and wages, to privatise a few state industries or even to balance the budget and introduce currency convertibility. None of these things will work properly without a whole lot of other institutional changes, such as effective legal systems, the rule of law and a state which can police it, clear and secure property rights and a social safety net. This is not to speak of more mundane matters such as the introduction of standard western accounting and banking techniques which are less and less known the further you move from the German-Polish frontier to the east or the south. The lack of appropriate institutions and traditions is becoming apparent in countries like Afghanistan and Iraq and will become even more so in any other countries which have the misfortune to be liberated by the combined efforts of American neo-conservative and liberal imperialists. When I first started speaking on the need to move away from equilibrium equations to a study of how markets actually function I had to recommend people to glance at a couple of very large American-style text books written from opposing political standpoints but at least emphasising that market capitalism is a process and that legal and political institutions matter. Since then a book has come out which both points out the gaps in the standard textbook approach and seeks to remedy them. Happily it is written by someone who places himself in the centre of the political spectrum and is absolved from the charge of being a "market fundamentalist". It is called Reinventing the Bazaar: a Natural History of Markets, by John McMillan, a professor at Stanford who edits the Journal of Economic Literature. (W W Norton and Co, 2002) He is somewhat more pro-market than the labelling suggests; and in fact he treats in some detail, incorporating the latest research, the institutional preconditions for well-functioning markets. He names five: you must be able to trust most of the people most of the time; you must be secure from having your property expropriated; relevant information must flow smoothly; any side effects on the third parties need to be taken into account; and competition must be at work. The book has not received all the attention it deserves. One reason is that the penchant of publishers for what they regard as popular titles obscures the real subject of the book. The casual purchaser in a bookshop might regard it as a social history of traditional bazaars ranging from those of Tashkent to the Commercial Road in east London. In addition the author has given way to publishing pressure for snappy chapter titles such as "He who can't pay dies", and "Come bid!" I cannot be alone in preferring chapter heads which guide the reader to the actual contents. Irrational Exuberance Finally I just want to refer to fascinating discussions going on under what might be called the foundations of economic behaviour. Many of them arise from the theory of games and cover such questions as the conditions under which altruism appears or the rationality or otherwise of economic decisions. There has also been an outcrop of "experimental economics". For instance audiences such as this one are asked questions about how they would divide a hundred dollar note under varying conditions. There is even a branch of neuroeconomics which tries to trace back decisions to events in the central nervous system. A guide to some of this work can be found in papers by the 2002 joint Nobel prize winner Vernon Smith. Nevertheless most of these discussions about the foundations of economics do not affect most of what I or others have been saying about practical applications. Markets are still important as discovery procedures; and they will only flourish on a long term basis under certain conditions. Nor do the arguments about fundamentals make much difference to the arguments against government sponsored arms sales or ridiculous export drives. The foundations of many subjects are controversial and obscure. Philosophers and mathematicians do not agree about the foundations of mathematics. And the arguments about the ultimate principles of physics rage very fiercely. Yet for most purposes it is still a working assumption that two plus two equals four or that the burnt child fears the fire. Unfortunately you will not become a cabinet minister or a business statesman if you insist on the economic equivalents of such propositions. I want to end with a slightly more down to earth assertion, which as far as I know is not to be found in any text. It has often been noticed that some people, especially leaders in business, fashion or sport, want to amass far more wealth than they can possibly use even on the most self-indulgent and sybaritic basis. The ultimate explanations here probably reach back into evolutionary psychology and the competition of the male animal to fertilise as many females as possible. We may, however, benefit from what now seems to be an irrational fetish or survival from the period when human beings were coming down from the trees. If Henry Ford had stopped developing the motor industry when his own personal wants had been satisfied, the cheap mass produced car would have been long delayed. If the Medici rulers of Florence had stopped acquiring wealth when their personal requirements were satisfied we would not have had much of the art and architecture of the Renaissance. In more recent times the sobering influence of people like Warren Buffet, the American fund manager who stepped out of the stock market in time, might not exist if he had wound up the fund after it had served his personal needs. The desire to pile up endless treasure beyond rhyme or reason would not be a healthy basis for the great mass of human activity. But we all benefit from the fact that some people are made that way. Irrational exuberance has its place - mainly outside the financial markets.
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