Turner, on “Economics, Conventional Wisdom and Public Policy”

Link to a nicer version of video at youtube. I had read several of Lord Turner’s speeches, a senior British financial regulator, but I hadn’t actually seen him talk before, even on video. His speech on financial regulation and economic thinking was fantastic. Like, really great, and is worth your time if you are thinking seriously about these things.

Here’s the speech transcript.

You have to hear him give it, because it’s a performance, this starts it off (my bold):

Let me begin with a caricature of the dominant conventional wisdom.

For over half a century the dominant strain of academic economics has been concerned with exploring, through complex mathematics, how economically rational human beings interact in markets. And the conclusions reached have appeared optimistic, indeed at times panglossian. Kenneth Arrow and Gerard Debreu illustrated that a competitive market economy with a fully complete set of markets was Pareto efficient. New classical macroeconomists such as Robert Lucas illustrated that if human beings are not only rational in their preferences and choices but also in their expectations, then the macro economy will have a strong tendency towards equilibrium, with sustained involuntary unemployment a non-problem. And tests of the efficient market hypothesis appeared to illustrate that liquid financial markets are not driven by the patterns of chartist fantasy, but by the efficient processing of all available information, making the actual price of a security a good estimate of its intrinsic value.

As a result, a set of policy prescriptions appeared to follow:
· Macroeconomic policy – fiscal and monetary – was best left to simple, constant and clearly communicated rules, with no role for discretionary stabilisation.
· Deregulation was in general beneficial because it completed more markets and created better incentives.
· Financial innovation was beneficial because it completed more markets, and speculative trading was beneficial because it ensured efficient price discovery, offsetting any temporary divergences from rational equilibrium values.
· And complex and active financial markets, and increased financial intensity, not only improved efficiency but also system stability, since rationally self-interested agents would disperse risk into the hands of those best placed to absorb and manage it.

Now of course, as a description of academic economics, this is not only a simplification but a caricature…the fact remains that while academic economics included many strains, in the translation of ideas into ideology, and ideology into policy and business practice, it was one oversimplified strain which dominated in the pre-crisis years.

Keynes, of course, famously wrote that ‘the ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than commonly understood. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist’. But I suspect the greater danger lies not with entirely practical men or women exempt from any intellectual influence, but with the reasonably intellectual men and women who are employed in the policymaking functions of central banks, regulators and governments and in the risk management departments of banks, who are aware of intellectual influences, but who tend to gravitate to simplified versions of the dominant beliefs of economists who are not yet defunct but still very much alive.

How true is that? And also this!:

Why did that translation occur? Jagdish Bhagwati, in his famous Foreign Affairs article on the ‘Capital myth’, talked of a ‘Wall Street/Treasury’ complex, of the fusion of interests and ideologies – and he argued that both played a role in the process by which liberalization of short-term capital flows became an article of faith of the Washington consensus, despite sound theoretical reasons for caution and slim empirical evidence of benefits. And in the wider triumph of the precepts of financial deregulation and market completion, both interests and ideology have clearly played a role.

Pure interests – expressed through lobbying power – were undoubtedly important to several key deregulations in the US, whose political system and campaign finance rules are peculiarly conducive to the power of specific lobbies.

Has anyone in the Obama administration said anything even half this provocative? Link to The Capital Myth article. And near the conclusion:

But knowing that market liquidity, speculation and price discovery is not limitlessly and always beneficial still implies a profound change of approach from that which dominated in the pre-crisis years. It implies that we should take financial transaction taxes and short-term capital flow controls out of the index of forbidden thoughts. And it means that in debates about prudential risk controls, such as capital requirements against trading books, we should be less susceptible than before to arguments that specific regulations are inappropriate because they will reduce market liquidity.

The whole speech is worth your lunch hour or whenever else you get a chance.

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7 Responses to Turner, on “Economics, Conventional Wisdom and Public Policy”

  1. Suppose his premise is correct (the simplified economic conventional wisdom pervades policy circles), what is the alternative? Regulatory capture happens in a world with and without this particular CV.

    Turner assumes the CV is in the interest of the financial industry, but that’s only because the financial industry was able capture regulators with the CV ideology. A CV that acknowledges we live in a second best world doesn’t make it less likely regulators will be captured. “Hey guys, you need to limit my competitors financial innovation because, while it gets us closer to the first best, it doesn’t quite get us all the way there and so its inefficient.”

    And think about it. Ideology that encourages complete, liquid markets *encourages* competition. On the face of it, why would that be in the interest of any individual or firm?

  2. joel says:

    Less is more? Is this like clothing–the smaller the fig leaf, the more you realize its important to monitor?

  3. engineer27 says:

    I’m sure it is easy for Turner to view us from the other side of the Atlantic, and cast aspersions on the too-cozy relationships between our lawmakers, regulators, and financiers. But his system of government and regulation is subject to the same pressures.

    US regulators (Timothy Geithner among them) were just as quick to point out the failings of Asian “crony capitalism” in 1997.

    None of which makes it wrong for him to say.

  4. chris says:

    if human beings are not only rational in their preferences and choices but also in their expectations

    But, of course, they’re not, so his conclusions are totally inapplicable to real economies — a problem that afflicts the whole “toy universe” school of economics. (Doesn’t he also require that all participants in the economy are omniscient? Which neatly predicts that there is no need to make any effort to prevent fraud, because it cannot exist when the victims already know about it. Also, advertising is unnecessary and, therefore, nobody will bother with it.)

  5. “But knowing that market liquidity, speculation and price discovery is not
    limitlessly and always beneficial still implies a profound change of
    12 For instance , Joseph Stiglitz, Using tax policy to curb speculative short term trading
    approach from that which dominated in the pre-crisis years. It implies
    that we should take financial transaction taxes and short-term capital flow
    controls out of the index of forbidden thoughts. And it means that in
    debates about prudential risk controls, such as capital requirements
    against trading books, we should be less susceptible than before to
    arguments that specific regulations are inappropriate because they will
    reduce market liquidity.
    To sum up therefore, we need new economic thinking, but even more
    importantly, we need to ensure that the public policy debate is not
    constrained by acceptance of an over-simplified version of one strain in
    economic thinking, nor constrained by the assumption that evolved
    institutional structures are necessarily unchangeable, but open to the great
    variety of insights which good economics has always given us.”

    I’m in the Kotlikoff/Kay camp, but I’d welcome a compromise if it follows this advice for how to conduct the investigation.

  6. Pingback: FT Alphaville » Further reading

  7. Pingback: Lord Adair Turner At INET (Also, More On The EMH) « Chasing Fat Tails

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