assumptions march final

8/6/2019 Assumptions March Final

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AssumptionsThe University of Warwick Economics Society Magazine

Issue Number 21, Spring Term 2009/10


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Dear Readers,

Welcome to the second Assumptions Magazine for the 09/10 academic year. We aim toprovide a mix of contemporary and theoretical articles across the economics spectrum.

This edition focuses on Warwick Economics Summit 2010, including an interview with TheEconomists Cartoonist Kevin Kal Kallaugher. Other subjects explored include neo-classical economics, the issue of UK Debt and the Greek crisis, as well as a literature review.Finally, our guest contributor is Warwicks Professor Andrew Oswald.

We hope you enjoy reading this issue and find it both thought provoking and engaging. Our

aim is to create a platform for debate within the wider subject, and perhaps inspire you to write for the magazine in the future. The next edition will be published in the AutumnTerm.

Yours faithfully,

The Editorial Team.


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Conte

ntsThe Greek crisis: time for the Eurozone to descend fromOlympus?

Is Britains public deficit such a problem?

Warwick Economics Summit 2010

Assumptions interview: Kevin Kal Kallaugher

Neoclassical economics, the financial crisis andheterodox economics

The human tendency to see patterns in random data

The end of laissez-faire: was Keynes right?

Chief Editor Chris Walker Contributors Vanessa AlbertShalin BhamraRob HarrisNicholas McSpedden-BrownProf. Andrew Oswald

Co-Editors Philip RowanTommaso Tomba

Designer Joseph OLeary


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From the outset of the current financial

crisis a lot of speculation has risen re-garding the robustness of the Eurozone.Many economists see the crisis as aninteresting test for the Economic andMonetary Union of the EU that couldprovide answers to the endless debatebetween the sceptics and fierce defend-ers of the euro. However, comparisonbetween the euro-members and their

counterparts who have not adopted thecommon currency has remained diffi-cult. The main element for comparisonis probably the UK which was one ofthe first to be affected by the bankingcrisis with the run on Northern Rock.On the other hand, Sweden has suffered less from the crisis than most of the euro-members, a relative advantage that can be explainedmore by its societal model than its non-membership of the Eurozone. In fact the Eurozone resisted for a longer time before falling intorecession, but the vulnerability of the different countries with regard to their membership of the currency union remains difficult to

estimate in view of the global economic storm.

The present economic downturn marks the first real test for the Eurozone, taking a turning point with the current Greek crisis.Everything started in October 2009 when Georgios Papandreous new socialist government opened Pandoras Box by announcing abudget deficit of 12.7% of GDP instead of the 3.7% claimed by the previous political leaders. This exceeds more than four times the 3%maximum level acceptable under the Stability and Growth Pact and is accompanied by a public debt representing 113% of GDP at theend of 2009, which could reach 120% in 2010. In reaction, credit rating agencies, beginning with Fitch, reduced Greeces rating whichincreased its risk premium of borrowing. This signal of a loss of credibility launched a new windof panic in the markets and unleashed vast amounts of speculation. During the last two months,

the European authorities and Trichets ECB have been caught between a rock and a hard place,facing a predicament of the credibility of the Euro versus European solidarity. They cannot bailout Greece and they cannot print more money since its charter does not allow the direct buyingof governments bonds. The idea of Greece leaving the Eurozone which was briefly evoked hasbeen eliminated, as well as resorting to the IMF which would undermine the role of theEuropean Central Bank. Moreover, it seems that the decision ultimately lies with France andGermany, more so than the European Commission or the ECB.

Despite the consensus on the impossibility of

Greece going bankrupt, the crisis poses a realchallenge for the Eurozone. Does it threatenthe break-up of the monetary union? Contraryto what some seem to fear, the Eurozone isdefinitely not yet under a sword of Damocles.In fact, the troubles of Greece have raisedseveral important issues that could have a posi-tive impact on future reforms if they are takeninto account, both from a political point ofview and regarding the financial titans.

First of all, the recent Greek odyssey has onceagain underlined the need for more controlsand regulation of the financial institutions and

The Greek crisis: time for the

Eurozone to descend from Olympus?

Contrary to what someseem to fear, the Eurozoneis definitely not yet under asword of Damocles.


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The UK, which has been moreconcerned with the integration of the

Eurozone given the depreciation ofSterling, is again likely to fall in line with public opinion, which remainslargely hostile to integration with theEurozone

by the bank. The European Commission has thus expressed its will to fight against the

distortion of data by taking proceedings against Athens. However, this was until thepress disclosed a few days later that not only did Italy and Portugal use the samestrategy, but also Germany and the United Kingdom. The involvement of states in thevery same questionable strategies as companies such as AIG highlights that betterregulation of the financial sector remains a Herculean task to achieve.

In light of these events and with all the disillusions of the global financial crisis, itappears difficult not to remain on the path of co-operation launched by the G20 in

2009. Even though the question of Community solidarity is not set in the text, it is a burning issue which has been increased by the risksof contagion of the Greek crisis. As the Competition Commissioner, Joaquin Almunia puts it, the difficult situation in Greece is a matterof common concern for the Euro area. There is serious risk of spillover to other parts of the euro area. Indeed, the Greek crisis is also acrisis of the Eurozone and investors pointthe finger at Portugal, Ireland and Spain, whose debts have been worrying too -creating the nice acronym PIGS. Accord-ing to the Markit CDS index, governmentbonds have reached a record high in these

countries as a result of the contagion fromGreece. Furthermore, French and Germanbanks together hold $115 billion exposurein Greece and much more in the otherPIGS. The interdependence of the financialsystem goes even further as Europeanbanks have lent more than $252 billion tothe Greek economy, according to the Bankfor International Settlements. After several

weeks of indecision at the European level,the German Chancellor Angela Merkelstated that, what happens in one memberstate affects all others, especially as we havea common currency, which means we havea common responsibility.

The Greek crisis confirms another wider problem that the European Union faces: the heterogeneity of the member countries of the

Eurozone. The economic performance of countries such as Greece has not yet caught up with the founding member countries of theUnion, despite meeting the economic and political conditions of admission. The strengthening of the EU should probably rely on areinforcement of its current framework to resolve the significant disparities between the different countries instead of considering anenlargement of the Union. The UK, which has been more concerned with the integration of the Eurozone given the depreciation ofSterling, is again likely to fall in line with public opinion, which remains largely hostile to integration with the Eurozone.

In conclusion, the Greek crisis reminds us of the longstanding Achilles heel of theEurozone: the inexistence of a common economic policy. The convergence ofeconomic and monetary policies that was supposed to be a consequence of the

Union has never really happened, impeding the performance of the Eurozone.Despite the reluctance of many countries, most notably Germany, the currentevents could be a trigger towards achieving better and much needed politicalgovernance of the Monetary Union. Notably, the crisis has confirmed that thesupposed advantage of a coordinated monetary expansion can have a strong

The involvement of states in thevery same questionable strategies ascompanies such as AIG highlightsthat better regulation of the financialsector remains a Herculean task toachieve.

Courtesy of Kal, The Economist, www.Kaltoons.com


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What is the furore about Britains public deficit? A ferocious debate has begun not only among politicians, but now prominent economists

and academics. In the run-up to a General Election, it is important to discuss the three main political parties contributions to the debateand analyse the current academic position.

Britains position, specifically in relation to the G7 countries and other European nations, can be examined. The UK entered the recession

in pretty good fiscal shape; with net debt well below 40% of GDP, the second-lowest in the G7 except Canada. And inevitably, all countries

debt is projected to rise over the subsequent two years. What is alarming is the rate of growth of British net debt; predicted to double over

5 years, while even the most debt-ridden countries forecasted debt growth, Italy and Japan, is only 20% and 50%, respectively.

But why is UK public sector borrowing forecast to increase at such a rate? A forecast based almost entirely on the composition of thegovernments revenue intake combined with the discretionary stimulus provided to the economy.

In the Pre-Budget Report, National Insurance and Income

Tax, which both provide over 50% of government revenue, are

forecast to fall by 8.5% while Corporation tax constituting

10% of intake is predicted to fall by almost 25%. Further-

more, VAT receipts, which make up 18% of total revenue, are

down 14% as a result of the temporary tax-cut. In addition,governmental Financial Sector Intervention (bank bailouts)

which constitutes to 12% of the National Debt, accentuates

the size of the debt.

As far as the adverse effects of the debt on the economy go, a

brief look at the yield curve for the US bond and UK gilt rates

shows little to differentiate between the two. The US starts

lower due to an initially lower discount rate (0 0.25%), butthe increases remain steady in relation to each other. In fact, as the UK generally has long maturities on its much of its debt, the UK rate

falls below the US for longer term debt. Clearly the markets believe that the current state of the finances need not be punished with a higher

risk premium. The much lauded concern that the UK could lose its Triple-A debt rating seems overstated, given the markets outlook.

Indeed, the credibility of the credit rating agencies themselves could be questioned, given their role in the current crisis.

It is safe to assume that the next General Election will be fought primarily on the way to deal with the current fiscal problems. The Tories

had previously been speaking loudly about their desire to cut the deficit as soon as possible if they got into office, while Labour have stuck

to their strategy of halving the deficit by 2014 throughout the past year. The Liberal Democrats remain characteristically vague about theirclaims to be committed to setting out the tough choices.

Following the publication of the first of three letters to The Timesand the FT, the Conservatives have claimed that their policy of fiscal

retrenchment is a consensus of economic opinion. Ex-MPC member David Blanchflower is quick to point out that the letter, while quick

to claim there is a compelling case that the first measures [will begin] to take effect in the 2010-11 fiscal year, offers very little substance

in terms of implementation.

The letter has been quickly rebutted by two letters to the FT, whose signatories include University of Warwick Professors Lord Skidelsky,

Marcus Miller and Peter Hammond, along with Brad DeLong and Joseph Stiglitz among others. They argue that urging a faster pace of

deficit reduction to reassure the financial markets implicitly accept[s] as binding the views of the same financial markets whose mistakes

precipitated the crisis in the first place! The third letter, signed by Lord Layard, Alan Blinder, Robert Solow and Rachel Lomax among

others, outlines that private households and businesses have had to increase their savings, which are used to purchase government debt and

0.00

20.00

40.00

60.00

80.00

100.00

120.00

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F ra nce G erma ny Ca n ad a It al y Japa n U nite d

Kingdom

United

States

2007

2008

2009

2010

2011

Figure 1: G7 Net Debt as % of GDP, Source: IMF World Economic Outlook

Is Britains public deficit

such a problem?


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2009 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP (a limited liabili ty partnership in the United Kingdom) or,as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

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NNOVATIVE?


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Warwick Economics Summit 2010 took place from the 19 th to the 21st

of February. This years summit promised much from the outset, withtickets selling out in record time and a strong line-up of inspiring,thought-provoking and challenging speakers. External students trav-elled from all over the world to take part, as 39 universities from 16

countries across 4 continents were represented, and it certainly didntfail to deliver. Whilst many speakers understandably chose to focus

their attention on the ongoing financial crisis, there were a wide rangeof subjects covered.

Friday saw Bob Janjuah, Chief Markets Strategist at RBS, begin theproceedings with a sobering talk on the problem of the current scale of

worldwide debt. This was followed by a characteristically animatedspeech from Lord Digby Jones, UK Ambassador for Trade and Invest-

ment. His main themes included the importance of skilling the peo-ple and that the UK has nothing to fear from the developing world if

it can do so. Lord Jones was also keen to dispel the myth that the UKdoesnt produce anything anymore, citing the aerospace, pharmaceuti-

cal and food industries. He also pulled no punches on the EuropeanUnion, insisting on a highest common numerator approach and thatthose (countries) with broken legs should be mended, not breaking

others legs

The evening ended on alighter note, courtesy of a very entertaining presentation from The Economists long-standing cartoonist Kevin Kal Kallaugher, who made a much welcome return to the

Summit (see Assumptions interview on page 9). Kal gave a humorous look back over

the last year for political satire and a look ahead through his famous caricatures anddrawings, and even gave a live lesson on how to draw Barack Obama.

Saturday began with a challenging talk from the Head of Warwicks EconomicsDepartment, Abhinay Muthoo, on democracy and economic performance. The audi-ence was encouraged to think about China and Indias common breakneck growth and

the differing political settings in which they take place. How does democracy affecteconomic growth? Might Indias economic performance be even higher were it to

follow China and become a non-democracy? These were just some of the thought-provoking questions raised. Professor Muthoo concluded that economic performance

needs first and foremost to work well, forwhich property rights enforcement, the es-

tablishment of the rule of law and contractenforcement are critical in their influence onexpectations.

Pete Lunn of the Economic and Social Re-

search Institute provided a fascinating in-sight into the revolutionary field of

behavioural economics and the impact its findings are having on traditional economictheory. Behavioural economics is the empirical study of economic behaviour, which triesto understand our economic instincts and why we do certain things. Dr. Lunn highlighted

Warwick Economics Summit 2010


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Saturday also saw the special guest appearance of none other than the Chancellor of the Exchequer, Alistair Darling. This wasntpart of the program but made for a welcome surprise as participants got to hear firsthand what is in store for the UK economy in

the future and to pose some challenging questions themselves.

The afternoon sessions began with a talk from Dr. Paul Wilmott on risk management and an alternative insight into the origins ofthe current financial crisis through an analysis of the derivatives market. Liam Halligan, economist and journalist, then tackled thequestion of the sub-prime debacle - what will future historians say? This was highly critical of the Western Worlds response

and that the cure is killing the patient. He also expressed concern about the potential inflationary pressures to come, the issue of

still high global leverage and the benefits of reintroducing the Glass-Steagall Act, separating investment from retail banking. Mr.Halligans other conclusion was that the financial crisis will result in a shift of global markets eastwards with the expectation ofgreater rewards and lower risks. Participants then had the opportunity to put their burning questions to a Question Time panel

which produced some lively discussion, before attending the inaugural Dinner and Dance event, complete with Economics quiz.

Sundays proceedings took a slightly different format in the form of several micro talks

on a diverse range of topics. Dan Ariely of MIT and Duke brought further thoughts onbehavioural economics, while Nikolaus Wolf of Warwick elaborated on how economics

should not ignore the past and how economic history can help us use, test and bin models.

Liam Delaney brought valuable insight into some of the European policy changes concern-ing behavioural economics. Nic Marks of the New Economics Foundation then gave afascinating talk on happiness economics and its use as an alternative measure of wellbeingcompared to GDP. In particular he cited the case of Bhutan which has adopted the Gross

National Happiness index and measures proposed by French President Nicolas Sarkozy tocome up with an alternative measure of wellbeing. Amongst some fascinating facts he

revealed that Costa Rica is the happiest nation in the world and the five secrets to wellbeing.Karen Chouhan of Equanomics spoke on the problem of the inequalities between the

general and ethnic minority populations which stimulated a lively question and answersession. Delegates were then given the opportunity to reflect on what they had heard overthe course of the weekend with a video montage of what economics means to me from

some of the leading thinkers from around the country.

A ti i t i


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Editors Tell us about your career and how you came to be at The Economist

Kal Every cartoonist has got a different story, because there are no classes on how tobecome a cartoonist, and my story is particularly curious. I came to the UK right aftergraduating from university, to do a bicycle tour leading a group of American tourists aroundthe UK. After this I got a job playing semi-pro basketball down in Brighton, but the teamhad some financial difficulties in the first season. I had done some cartoons at university,for the school paper, and my senior thesis was a 13 minute long animated cartoon. So whenthe basketball team started having trouble financially, I went to the streets and started doingcaricatures. Eventually I started applying to the papers and got myself a trial at The

Economist. Now I knew absolutely nothing about British politics, so my friends from thebasketball team told me to just sit down the night before and watch Newsnight. On Newsnight, there was a feature about Dennis Healy.Now this is a guy who is perfect for cartoonists: a round tomato of a face with big bushy eyebrows and little buck teeth like a rabbit,so I sat down and sketched away. The next morning at The Economist I sat down and they said, Okay can you draw Dennis Healyfor me? So I threw it together and that was 32 years ago.

Eds With reference to The Economist, how would you say you keep political satire, non-partisan?

Kal In some ways, satire is through some sort of filter of your own, through the prism of your own experience, and partisanship

comes if people are seeing it through a very narrow filter. I like to keep my filter broad, where I can see the mistakes and problems thateach party from each country has. It doesnt mean that I treat every party the same, but Im not going to be prejudiced before I cometo the facts, the essence of journalism. Having said that I regard myself as a columnist, whos a commentator and is in the business oftrying to critique things that are going wrong. So the line I like to give is Im 100% in favour of everything thats right, but I dont thinkthat any one party in power has a monopoly on all things right. Even as a voter and participating in a democracy you can see peoplemaking mistakes and who are worthy of criticism. Politics by its nature involves all sorts of compromises, particularly when you arecampaigning on all sorts of ideals but when it comes down to it you need to do all the stupid stuff. We in the press, our business is tokeep everyone straight and ensure they are serving the voters as best as possible. Essentially I try to be fair and sound in my judgementsbut Im still looking at things from my own personal point of view to some degree.

Eds Would you say you are given quite a free reign in terms of your cartoons?

Kal To some degree they give me a freereign but in other ways Im working within cer-tain structures. You work in a society where youdont want to be looked on as racist, sexist orwithin the realm of culturally offensive material.Then you work within what they consider the

parameters of their political point of view. TheEconomist is very tolerant but of course has aspecific agenda. Nothing is signed, they speak asa singular voice, a voice which is quite libertarian,but then they dont want somebody veering wayoff course because it works outside of theirworld. Within my opinions I work within theirframework. There has been an odd occasionwhere I have come up with a cartoon which is

diametrically opposed to their lead editorial, sothey say do you mind holding it for this week andrun it again next week. I have a great deal offreedom, but with all freedom comes responsi-bility and that is to do something which is

In some ways, satire isthrough some sort of filter of

your own, through the prismof your own experience, and

partisanship comes if peopleare seeing it through a verynarrow filter.

Assumptions interview:

Kevin Kal Kallaugher


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America. One of the interesting things is on our website

we can now get comments on the cartoons, and I getscores of comments on cartoons which broach 3 majorsubjects: Iran, China and Russia. Some of them are officialcomments, people whose job it is to criticise, but a lot ofthe time its people not understanding the joke and thecontext. Some people like to wilfully misinterpret things,but thats another story entirely. But there is another sideto the story, take the Danish cartoonists. Here is a situa-tion where if you misread your audience, or if they were

only targeting Denmark but it is read elsewhere, it hasmassive implications. It is one of the minefields in front ofus. That story isnt over yet, there have been cartoonistsoutside Denmark who have been arrested and beaten upbecause they have done things. There was a comic stripguy in Burma who drew a comic with a cat called Muham-mad. Some people took this to be offensive, there wereriots and he was arrested and put in jail. This story is goingto play and play.

Eds Youve been at The Economist for 32 years now; do you think its stance has changed a lot following the crisis? Or indeed yourstance?

Kal I guess as a professional cartoonist Ive had my fair share of minor spats with different groups that have objected to work thatyou do because satire is a negative art in which youre making fun of people; youre always ticking people off. But its the question ofwhen you tick people off so much that you become ineffective because like I said were columnists, Im trying to get a point across, Imtrying to spur a discussion. But if people are so hot-headed and angry that the discussions not heard over the yelling then you haventdone your job. The Economist has maintained a fairly consistent line about freedom of expression and tolerance for decades, so in that

way I think theyve been remarkably consistent. What I think is amazing is their consistent support of me as a satirical voice in theirpublication and understanding that this is a valuable thing to do in journalism.

Eds Do you watch a lot of cartoons or animated films? Which one would you say is the best?

Kal Yes I do, I watch them all as much as I can. I love the Simpsons and South Park. From a 3D animation and technical point ofview Pixar are fantastic. But the man hours that are involved with that are huge and so the films are dripping with beauty and you getso engrossed. Avatar is full-on animation with the guys in motion capture suits and completely digital sets. I can imagine in a decadefrom now motion capture will be fairly inexpensive and the political cartoons that we see in newspapers will instead be done by guys

who will have built a dozen main political characters and will produce a 30 second full 3D animation in motion capture of the daysnews. They recreate what happened in 10 Downing Street - the real conversation behind the news today.

Eds What would you say are your main sources of inspiration?

Kal Well part of it is just listening to the news. Even in my studio in Baltimore Ill listento Radio 4 and the news quiz in the UK. I love the Daily Show and to hear great satirists atplay. Its a constant search to try and keep abreast of whats going on in the news so Ivegot lots of websites I go to, newspapers, magazines and blogs. You try to get a global feelfor different points of view and piece together as much information as you can. WatchingTV, listening to the radio, its non-stop ingestion my brains complete mush by the endof the week. But I think trying to keep up with everything is what gives you the inspiration.

Eds What do you think The Economist will do whenever youre gone?

I have a great deal offreedom, but with all freedomcomes responsibility, and thatis to do something which is

journalistically sound and hassome integrity.

Will China Lead the Global

N l i l i th fi i l


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Will China Lead the Global

Economy to Recovery?

A recent online poll organised by the Real-World Economics Review (RWER) Blog, who edit the online economics journal of the samename, has come to a close. The poll asked voters to nominate economists for the Dynamite Prize of Economics, to be awarded to thethree who contributed most to enabling the Global Financial Collapse (GFC). The economists short-listed as the final ten were: FisherBlack and Myron Scholes, Eugene Fama, Milton Friedman, Alan Greenspan, Assar Lindbeck, Robert Lucas, Richard Portes, EdwardPrescott and Finn Kydland, Paul Samuelson and Larry Summers. In the end, the winner was Alan Greenspan, followed by MiltonFriedman and Larry Summers.

The editor of RWER, Edward Fullbrook, said that the prize had been established in response to attempts by economists to evaderesponsibility for the crisis by calling it an unpredictable, Black Swan event. While the unpredictability of the GFC is open to

question, it is interesting to see that he considers all of the aforementioned economists fall into the general denomination ofneoclassical economists. Indeed Fullbrook stresses that it is the delusional mindset of neoclassical economists that caused theGFC. There are realist approaches to economics but which through power politics have been suppressed in universities and excludedfrom government policy making. As a consequence, a poll has now begun in order to determine which non-neoclassical economistfully deserves the Revere Award in Economics (in honour of Paul Revere, an American activist during the American Revolution). Itwill be awarded to the 3 economists who saw the GFC coming, and whose work is most likely to prevent another GFC in the future,says Fullbrook.

However, the task of clarifying what exactly makes neoclassical economics so pervasive is not an easy one. E. Roy Weintraub, Professor

at Duke University, notes that the American economist Thorstein Veblen was the first to use the term in a pejorative sense, todistinguish marginalists in the tradition of Alfred Marshall, from those in the Austrian School. However it is now known more or lessas a synonym for mainstream economics. He stresses that neoclassical economics is indeed more of a meta-theory, of which thefundamental assumptions are 1. People have rational preferences among outcomes, 2. Individuals maximize utility and firms maximizeprofits. 3. People act independently on the basis of full and relevant information. It is alsodefined methodologically with a strong use of mathematical and analytical methods, namelythrough constrained optimization problems, and emphasises the existence of explicitequilibria.

Yet this general framework doesnt do much to show the potential dangers of neoclassicaleconomics. Christian Arnsperger, professor at the University of Louvain in Belgium, andYanis Varoufakis, professor at the University of Athens in Greece, however, provide ascathing account of how such a framework can be pushed to excess. In a paper written forthe Post-Autistic Economics Review (predecessor to the RWER), they enunciate the three axioms responsible for [the] theoreticaloeuvre, practical irrelevance and, thus, discursive power [of neoclassical economics]. They are right to stress first of all, however, thatcriticisms of neoclassical economics that refer to its positing hyper-rational bargain-hunters, never able to resist an act which bringsthem the tiniest increase in expected net returns and other neoclassical features such as market-clearing, selfish individualism, orPareto optimality miss their target as these are not ubiquitous and necessary features of neoclassical theory. They then define three

axioms, which, on the contrary, underpin all (and only ) neoclassical theory: methodological individualism, methodologicalinstrumentalism, and methodological equilibration. The first implies that socio-economic explanation must explicitly be sought at thelevel of the individual, rather than any wider social structure. The second means that all behaviour is to be understood as a means for

maximising the satisfaction of preferences, however dynamic and endogenous they may be. Thefinal axiom refers to the axiomatic imposition of equilibrium as a situation that must necessarilyoccur. The authors also claim that such meta-axioms are beginning to develop much closerlinks than before, and conclude that it is, therefore, uncontroversial to state that every aggregatephenomenon scrutinised by neoclassical minds is explained increasingly and exclusively as someaxiomatically imposed equilibrium emerging from the interaction of instrumentally rational

individuals who are either optimising consciously (as in rational choice or game theory) or aredrawn to such behaviour through a process of natural selection (as in, for instance, evolutionarygame theory). And they assert that the meta-axioms, as the foundations of neoclassicaleconomics, have gained such discursive power and resistance to pluralism for two reasons: inquestioning the meta axioms one will never get published in a top journal but more importantly

it is the delusional mindsetof neoclassical economiststhat caused the global

financial crisis

Edward Fullbrook

Neoclassical economics, the financial

crisis and heterodox economics

The human tendency to see


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When looking at data, human

beings readily discard theoriesand patterns that do not work,

whilst subconsciously dreamingup new ones.

76% of the time we will beable to write a paper proving,at the 0.001 level of statisticalsignificance, some version ofcoins come down heads on

March 27th.

Empirical evidence is more important than theory. But when I was young I did not appreciate how easy it is to find exciting, but illusory,

patterns in data. With a collaborator, Amanda, I am doing experiments and we have a theory that we call Time of the Day Effects,hypothesising that the time of day has important consequences.

I am working on coin-tossing - heads and tails. She is working on the spin of a roulettewheel, with only two colours - red and black. I throw a coin each morning 6 times; then thesame in the afternoon: 12 throws a day. I do this for a week, so the sample size is 84. In theother experiment, Amanda is spinning her roulette wheel. She also does it 6 times in themorning, and 6 in the afternoon, for 7 days. Our total observations are therefore 168. Weagree to collaborate on any finding in either experiment, whatever turns up, and to send a

jointly authored paper to the Journal of Scientific Discoveries.

How likely are Andrew and Amanda to be able to write a paper with a time-of-the-day effect thatis statistically significant at the 2% level (p< 0.02)?

The probability of flipping a coin 6 times in a row and getting a head each time is (0.5)^6 = 1/64.Hence the probability of this event is less than 2%. So what is the chance that, if I search acrossall my data, there will be at least one morning or afternoon with a run of a head or a tail? It is (1 P), where P = probability there will be neither a heads run nor a tails run).

There are two types of run, one for heads and one for tails. So the probability of no heads or tailsrun for my experiment during the week is (31/32)^14 = 0.64. Therefore 36% of the time we willbe able to write a paper finding some version of heads come up on Wednesday afternoons. ButAmanda is also working in her lab and generating data. The probability that either Amanda or Ifind a result is (1 P), where P = probability there will be neither a heads or tails run nor a red orblack run. The probability that there will be neither is (31/32)^28 = 0.41.

Thus 59% of the time we will be able to write a paper proving, in a way that greatly exceeds theninety-five confidence level, some version of heads come up on Wednesday afternoons or redsoccur on Saturday mornings. However, this pattern is an illusion caused by excessive searching.

Suppose we extend our theory to day of the year effects and that our referees tell us we need to enforce a 0.001 statistical-significancelevel. We now throw the coin ten times every day for a whole year, and also spin the wheel ten times. The chance of a head comingdown ten times in a row is 1/1024. Because there are 365 days in a year, the chance that neither Amanda nor I get any run of 10 in asingle day is thus (1 ((511/512)^730)) = 0.24. Hence, 76% of the time we will be able to write a paper proving, at the 0.001 level ofstatistical significance, some version of coins come down heads on March 27th. However, we have again subconsciously searched too

much.

When looking at data, human beings readily discard theories and patterns that do not work, whilst subconsciously dreaming up new ones.They latch on to exciting results that they had not neither forecasted nor expected. If quizzed by sceptics, researchers tend to reply: Butmy result is statistically significant at the 1% level. This is a pervasive problem; we are all prone to the error, and it is a mistake to behaughty about it. But independent replication is the only convincing check on a finding.

Myself included, we all need humility when undertaking empirical research. This isespecially true when using small data sets of less than 1000 observations. Therefore I try

to ask myself: (i) can I check my exciting discovery by making sure that it is there withinsubsamples of my own data, by splitting the sample into men and women, or young andold, or before 1980 and after 1980? (ii) did I come up with my theory ex post, afteralready seeing the data? (iii) have I, without realising it, searched across lots of possibleempirical patterns before stumbling on my exciting finding? Unfortunately, if we

The human tendency to see

patterns in random data

The end of laissez-faire:


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In his short but powerful piece entitled The End of Laissez-Faire, Keynes walks usthrough the rise of laissez-faire as a political doctrine and the importance of govern-ments in limiting large corporations. However, was Keynes view correct? Can it reallybe applied to the real world?

The glut of front-page stories on multi-million dollar bonuses and surprisingly high profits inthe news at the moment suggest that the banking industry is actually recovering from theeconomic downturn. Well, in the USA at least. In fact, as I write this article a number of seniorexecutives at top investment banks are foregoing their bonuses in a desperate attempt to get a

solid pat on the back from Average Joe who will cry out: what a great bunch of blokes, I guessI can forgive you.

Whilst it is safe to say the general consensus favours a punch in face, one cannot forget theimportant role for the world economy that these banks play, with large profits on their partunfortunately being good news. The financial services play a huge role for the UK economy,accounting for more than 10% of UK GDP (Financial Times), and the global economicdownturn certainly opened many peoples eyes to the importance of institutions in society.

The global economic downturn brought up much deeper concerns, such as an imminentcollapse of capitalism, or an expected revolt by the masses against the fat cats of industry. Now,in light of signs of recovery, governments are keen to clamp down on the financial services andessentially reduce the large inequality gap between the average person and the super rich.

Enter Keynes work The End of Laissez-Faire. Despite its basis from a lecture givenin 1926, the text could not be more relevant to the world of today with an intensediscussion on the rise of the political doctrine that is laissez-faire, the possible solutionsas to when it needs limiting, and where it may reach its optimal position and begin to

decrease in popularity as a dogmatic idea.

Keynes firstly sets out the roots oflaissez-faireand the importance of the concept ofindividualism to its existence. Hume defines utility as that of just Calculation, and asteady preference of the greater Happiness with Keynes making it clear that the originoflaissez-faireis in political philosophy.

He raises ideas about the concerns of society and how they compete with those of the individual; citing Rousseau and his General Will,where equality is not only the starting-point but the goal. Keynes draws parallels with laissez-faire, raising the issue of the invisible hand

in society, noting that the utility of the individual and its conflict with that of society is something the political philosopher no longerneeds to be concerned with as [the business man] could attain the philosophers summum bonumby just pursuing his own private profit.

Of course in todays world, one can question the idea of the invisible hand. The mass unemployment of only a number of months agobeing still fresh in the publics mind and making the almost unreal bonuses more akin to a knife in the back of society. The sheer levelof trust Keynes has in the invisible hand certainly shakes the credibility of his work, and although he does question it, the extent towhich he does is unsatisfactory. Despite this, his initial analysis is clear in laying down the foundations and ultimately provides the readerwith a credible account as to whylaissez-faireis so dominant today.

In his second chapter, Keynes continues to explain how the concept oflaissez-faireis no longer the child of philosophy but in fact has becomea concept of concern for political economists. He states a key case infavour of laissez-faire is that protectionism has caused a decline in theexporting of manufactured goods His case study of Marquis

The end of laissez-faire:

was Keynes right?

The sheer level of trust Keyneshas in the invisible handcertainly shakes the credibility ofhis work, and although he doesquestion it, the extent to whichhe does is unsatisfactory.

Keynes almost immediately prescribes acure to the problems of laissez-faire: theunderstanding that one of the finest


15/16

Of course one can poke holes in this idea of equalisation, with the bonus-culture today doing all it can to prevent a closing of theinequality gap. In the long run, this gap cannot be expected to close with senior executives finding it increasingly difficult to turn downbonuses, with Eric Daniels of Lloyds Banking Group having to yield to growing pressures to waive his 2.33m bonus (hardly the signsof an individual eager to equalise societal well-being).

It is only in chapter four where Keynes critiques laissez-faire. However when he does it is short, clear and direct. Firstly, he claims thatthere are no guaranteed rights under the doctrine. Secondly he attacks the idea of the invisible hand, explaining that it is not a correctdeduction that enlightened self-interest always operates in the public interest. Although short in his analysis, Keynes almost immediatelyprescribes a cure to these problems: the understanding that one of the finest problems in legislation is knowing when the state should

interfere in public life.

Keynes proposals begin promisingly claiming that semi-autonomous bodiesare the key to progress and that institutions like universities and the Bank ofEngland are a sign of things to come. In todays world this does appear acredible statement, with the nationalisation of firms and the rigorous policingof industries such as utility companies being common place.

Where Keynes falters, and rather significantly, is in his explanation of the

tendency of big enterprise to socialise itself. He essentially feels that as large companies grow, the relationship between stock holder andmanager begins to waver. Stock holders are content with reaping the benefits of a steady revenue flow. However, the management isconcerned with avoiding criticism from the public. This leads to Keynes claiming that the battle of Socialism against unlimited privateprofit is being won in detail hour by hour.

Surely it is absurd to assume that large organisations begin to care about public welfare as oppose to profit maximisation? It is the natureof human society to believe that more is better, and as a result profit maximisation will never be sacrificed for societal welfare with regardsto a private firm. (Do we honestly expect Goldman Sachs to halt their current level of generation of $439 per second?) As a result, Keynesis wrong in stating that socialism will overtake laissez-faire,

with the large profits being reported by large banks so soonafter the global downturn reflecting their monolithic power.

Overall, Keynes claims that the debate as to whether laissez-faireis declining is a psychological one, rather than a technicalone. He states an argument outlining the conflict betweenreligious views and the nature of man, with religious individ-uals tending to denounce material possessions, whilst mencannot do without the money-motive.

Keynes ultimately feels that capitalism cannot be judgedobjectively, but states that when proper managed it is moreefficient in achieving economic ends than any other system. Ifeel that in his text, Keynes makes a number of useful insights.His third chapter spends time analysing the relationship be-tween Darwinism and laissez-faire, claiming both to be naturaland efficient. It is certainly well written and makes a numberof useful arguments regarding the rise of free markets, whilst

noting the need for regulation and the fact that there is a rolefor the state.

Despite these positive points however, Keynes does stumblein places I feel that his argument could have been somewhat

Keynes ultimately feels that capitalismcannot be judged objectively, but statesthat when proper managed it is moreefficient in achieving economic endsthan any other system.


16/16

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