Forgot About Keynes

Economists on Economics

This is the first post in an open-ended series on methodology—the way in which economics is done—where I’ll be collating quotes by professional economists (and other academics) on economics itself. The idea comes from a post by Unlearning Economics. This will be convenient for me as a way of bookmarking ideas and opinions for later use and should, I hope, be entertaining and easier to digest than my longer articles. 

THOMAS PIKETTY
In Capital in the Twenty-First Century, Piketty bemoans the artificially created gulf between economics and the other social sciences with which he argues it belongs. Economics may pretend to a greater degree of academic rigour, but its use of quantitative methods is often gratuitous.

Economists today are full of enthusiasm for empirical methods based on controlled experiments. When used with moderation, these methods can be useful … But these new approaches themselves succumb at times to a certain scientistic illusion.

The new methods often lead to a neglect of history and of the fact that historical experience remains our principal source of knowledge … To be sure, historical causality is always difficult to prove beyond a shadow of a doubt … Nevertheless, the imperfect lessons that we can draw from history, and in particular from the study of the last century, are of inestimable, irreplaceable value, and no controlled experiment will ever be able to equal them. To be useful, economists must above all learn to be more pragmatic in their methodological choices, to make use of whatever tools are available, and thus to work more closely with other social science disciplines. (Piketty, 2014)

YANIS VAROUFAKIS
Varoufakis reveals in a public lecture that while he considers himself to be a Marxist, the research he carried out in the 1980s for his PhD could not be further removed from these personal beliefs. His colleagues then were neoclassicals and it turns out that they were not as earnest as he hoped they would be.

I had this bourgeois view that if you presented these Anglo-Saxon professors with a mathematical proof that their model is wrong, that they would care. They don’t. They used to. You know, people like Frank Hahn, Kenneth Arrow and so on … the older generation cared about the seaworthiness of their theoretical vessel. This lot now don’t give a shit … and it is very discouraging. (Varoufakis, 2013)

Economics, he warns, is bad for your mental health. Why study it then? Because, as Joan Robinson argued, you need to understand economics in order not to be deceived by economists … especially in an age when its concepts are couched in the wantonly opaque language of mathematics.

JOHN MAYNARD KEYNES
In From Political Economy to Economics, Ben Fine and Dimitris Milonakis contrast the views of Bertrand Russell with those of John Maynard Keynes. While Russell believed in formalist analysis, Keynes insisted upon common sense reasoning.

The atomic hypothesis which has worked so splendidly in physics breaks down in psychics. We are faced at every turn with the problems of organic unity, of discreteness, of discontinuity – the whole is not equal to the sum of the parts, comparisons of quantity fail us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied. (Fine & Milonakis, 2009: 277)

Keynes decries the attitudes of even his contemporaries, whom he sees as obsessing with adhering to the strictures of scientific methods, regardless of whether or not they are truly appropriate.

Keynes … referred to Russell’s method as “extravagantly scholastic”. He thus reiterated the warning … that “in writing economics one is not writing either a mathematical proof or a legal document”’ (Ibid.)

Why Isn’t Every African Woman a Millionaire?

This is the final part of a series of posts on (ir)rationality, meritocracy and inequality. It started with a premise taken from George Monbiot—”If wealth was the inevitable result of hard work and enterprise, every woman in Africa would be a millionaire”—and it ends here with a short answer to a big question: what is it that makes us successful?

Monbiot’s statement can be boiled down to the question: why is it that hard work is rewarded so well in some parts of the world while in others, it’s possible to work tirelessly for a lifetime on subsistence wages? As it happens, Jared Diamond took a broad-brush approach to this very question and came up with a good, simple answer: it’s geography, stupid.

GUNS, GERMS AND STEEL
Diamond’s 1997 bestseller and the three part mini-series that followed were inspired by a question he was posed by Yali, one of the many Papua New Guineans he had come to know as a result of his field work (on the island’s native bird population):

Why you white man have so much cargo and we New Guineans have so little?

Why is it, in other words, that westerners have such advanced technology, while in the twenty-first century, many Papua New Guineans are still hunter-gatherers? This question originally stumped Diamond, but more than three decades’ worth of study yielded an explanation narrowed down to three main factors—guns, germs and steel—all of which developed as a result of another primary factor: geography.

Yali caught me by surprise 30 years ago. I had no idea what to say to him then but now I think I know the answer. Yali, it wasn’t for lack of ingenuity that your people didn’t end up with modern technology. They had the ingenuity to master these difficult New Guinea environments.

Instead the whole answer to your question was geography. If your people had enjoyed the same geographic advantages as my people, your people would have been the ones to invent helicopters. (Diamond, 2005)

In order to show us how the New Guineans live, Diamond takes part in some of their daily activities, including a notable scene in which he practises firing an arrow.

Hunting wild animals, as many New Guineans still do, takes skill, stealth and an encyclopedic knowledge of one’s surroundings. Firing an arrow is just one of these skills and while Diamond had managed to work his way up to being a professor at UCLA, he was way, way out of his depth in New Guinea. His instructor is less than impressed. The children watching from a few feet away are even less impressed and make no effort to conceal their laughter.

What Diamond illustrates in this scene is the extent to which we all rely on our heritage to get by. If you’re not taught about the plants and animals of New Guinea, if you don’t practise building shelters or hunting and gathering with the locals, you will go hungry and sooner or later you will die or be killed.

The children of New Guinea only make it to adulthood because they are educated by their elders and in this respect, we are all alike. There’s nothing about individuals that makes any one of us so especially adaptable to our surroundings that we can survive on our own. This is a point made compellingly by Thorstein Veblen, one of the pioneers of institutional economics.

OUR HERITAGE DOES MOST TO DEFINE WHO WE ARE AND WHAT WE ACHIEVE
Wherever we meet people, we meet a body of knowledge—languages, tools, processes and so on—used in the quest of a livelihood. This body of knowledge, that Veblen describes as “the immaterial equipment”, is a joint stock – the product of the contributions of all those that came before us.

The requisite knowledge and proficiency of ways and means is a product, perhaps a by-product, of the life of the community at large; and it can be retained and maintained only by the community at large. (Veblen, 1908: 519)

What Veblen is describing here is the essential infrastructure that holds up the society and the economy that we live and work in – our technological, cultural and institutional heritage. We inherit languages, physical machinery and ways of living and working that have evolved over thousands of years without any involvement from any one of us. Inheritance is the operative word here, because the credit for all that we inherit is due to those we inherit from, our forefathers.

This is, in a nutshell, is my answer to the question posed by Monbiot’s statement. The reason that hard work is rewarded asymmetrically is because we are all rooted in our surroundings. What we achieve is not down to us, for the most part, but rather is the result of blind luck – the most important factor being our place of birth. Take an American professor and put them on a foreign island and their skills and knowledge mean little, because they have been uprooted from everything they know. As Jonathan Nitzan and Shimshon Bichler put it:

the usefulness of any given computer depends crucially on the current state of technology. With the arrival of new software, the hardware quickly ends up in the junk heap; the new technology makes it socially obsolete, and although it may have lost none of its operational features, it is no longer a ‘capital good’.

Or rolling history in reverse, a modern factory producing semiconductors would have been a worthless (and indeed meaningless) collection of physical objects during Veblen’s time – first, because it could not have been operated; and second, because its output would have had no perceptible use. In these and all other cases, the transformation of a physical object into an economically useful capital good can neither lead nor lag the existing ‘state of industrial arts’.

The same logic applies to labour power and raw materials. A jungle tribesman would be lost in a modern factory, much as a bank manager would be lost in the Sahara desert. Similarly, ancient stone utensils are as useless today as was petroleum before the invention of modern combustion engines. Labour, land and capital goods are obviously essential for production, but only because they are part of a comprehensive social and cultural process. (N&B, 2009: 222)

STANDING ON THE SHOULDERS OF GIANTS
The Imitation Game (2014) gives us a glimpse into the life and genius of Alan Turing and deftly illustrates the debt we owe to him and all the others involved in decoding Nazi communications during World War II. As the film shows, Turing, drawing on the knowledge and infrastructure of his own time, imagined and oversaw the production of what we now know to be one of the earliest universal computers.

Without the likes of Alan Turing, the world may have had to wait decades longer for the appearance of this invention upon which so much of modern productivity depends. It may never have been developed. Nevertheless, we have it and we benefit from it enormously – and yet almost no one alive today played any part in its creation. Our generation inherited computer science and we are presently using it to generate technologies and improve ways of living and working that will in turn, benefit future generations.

The reason that I place such emphasis on heritage is because the modern myth of the individual has it backwards. We can’t make it on our own. We all know this in our heart of hearts and yet Anglo-American society is based on the lie that we can.

If we found ourselves, as Diamond did, in rural New Guinea, we would have to rely on rudimentary technology such as bows and arrows, canoes and tools fashioned from bamboo to get by. Even then, we’d have to know how to use a canoe or fire an arrow for these things to be useful to us – and we’d only have access to these through the locals, whose trust we would have to earn.

Taking this point further, while Alan Turing’s genius enabled him to conceive of a machine that could in turn, crack the Enigma machines that the Nazis used to communicate, such a machine could not have been constructed without the necessary funds or manpower. Alan Turing, it turns out, is only as useful as the country his genius resides in and the uses that country puts it to.

If it wasn’t for our technological heritage, we would have to literally reinvent the wheel every generation or so. The reason that we don’t all have to personally conceive of and construct a computer ourselves, for instance, is because we were fortunate enough to have been born at a time when that had already been done and made widely accessible enough that we had one close by. This is what Veblen means when he says that:

Individual initiative has no chance except on the ground afforded by the common stock, and the achievements of such initiative are of no effect except as accretions to the common stock. And the invention or discovery so achieved always embodies so much of what is already given that the creative contribution of the inventor or discoverer is trivial by comparison. (Veblen, 1908: 521)

That is, no matter how talented, hard-working or ingenious we are as individuals, we’re not anywhere near self-sufficient enough to make it on our own.

HARD WORK
The purpose of this post isn’t to say that hard work isn’t important, because it’s absolutely necessary to doing well. There’s not a single person on earth that doesn’t appreciate that. The purpose of this post is to say that hard work isn’t enough. If we’re going to live well, working hard isn’t going to be sufficient. To live well, we need to work hard and be lucky. Most of all, we need to be born in the right place and if at all possible, to the right parents.

A prodigious mathematician, say, born in one of the most developed countries in the world has the best chance possible to succeed at what they know and do best. A prodigy born in one of the least developed countries cannot rely on hard work alone. Srinivasa Ramanujan was one such prodigy. He had the requisite talent but, isolated from the networks and the infrastructure that his foreign peers benefited from, he was headed nowhere. It was only after he was able to travel to England that the world had any way of putting his immense talent to use.

To answer the question as it is put in the title, the reason that not every African woman is a millionaire is because economic rewards do not accrue to the hard-working alone. Financial success results from hard work situated in a sufficiently sophisticated economy – which is really just another way of saying that hard work is nothing without the efforts of others.

Hard work is a necessary component of success but it is not sufficient. This is essentially why children born into wealth do better on average than children born into poverty and this is why our outcomes in life are not down to ourselves alone. Too many of those that preach the value of hard work in fact benefited enormously from wealth they inherited and too often these people take credit for work that is done by machinery, institutions and processes that they played no personal part in developing.

RECOGNISING OTHERS AND GIVING BACK
We’re deep into Hollywood’s awards season right now and the acceptance speeches that have been given so far and remain to be given are marked by one thing in particular: mutual recognition.

It’s remarkable from a methodological point of view that nearly every one of these speeches involves thanking others. The individualism upon which mainstream economics is founded sees each of us as fundamentally self-interested and calculating people. And yet nearly everyone who accepts a Golden Globe or an Oscar finds themselves overcome with emotion, often so much so that they struggle to speak on stage.

Russell Crowe, in a particularly memorable speech in 2001, starts by dedicating his award to two people in his life, his grandfather and his uncle, that were pivotal in inspiring him to the artistic heights that he reached … and ends with an attempt to inspire future generations.

You know, when you grow up in the suburbs of Sydney, or Auckland, or Newcastle, like Ridley or Jamie Bell, or the suburbs of anywhere, you know a dream like this seems kind of vaguely ludicrous and completely unattainable. But this moment is directly connected to those childhood imaginings. And for anybody who’s on the downside of advantage and relying purely on courage: It’s possible.

This kind of behaviour makes no sense within the framework of mainstream economics but it is just the kind of behaviour that cultivates society. We’re all unselfish to some degree and we rely on this kind of altruism to get by. Without the drive to create ideas, machines and cultural artefacts that last generations into the future, we leave our children impoverished. This is how we give to future generations and how we benefit from past generations – and why it’s vitally important that we recognise the part that others, past and present, play in our own livelihoods. Our success is not down to ourselves alone, it is possible only because of the efforts of others.

Trickle-Down is Drowning the Middle Class

At the beginning of a new two-part series on inequality, Jacques Peretti notes that: “when [he] was growing up in the 1970s, the idea that the aristocracy ruled Britain had gone, they were finished. But now there’s a new aristocracy who have taken over – they’re not the landed gentry, they’re the super-rich.”

Britain now has 104 billionaires – that’s more per head than any other country in the world. And the way that this group justifies its huge financial and political power is by recourse to trickle-down economics. Multi-millionaire Rob Hersov explains that the rich are good for Britain:

We want more super-rich people here in England. Why? Because if they invest here, if they hire people, if they use taxis, if they go to restaurants, they’re creating wealth for people in England. It’s not trickle-down, it’s trickle-through. They’re creating opportunities for other people.

TRICKLE-DOWN
Trickle-down is the theory that poverty can be eliminated in the least developed countries in the world through free markets and free trade and that GDP can be increased in the most developed countries through lower taxes for the richest. Arthur Laffer explains that:

Rich people are different than most people. The rich is the one group of people where you lower tax rates, you will get more revenues and every time we’ve raised those tax rates on the rich, they’ve paid less … If you tax rich people and give the money to poor people, you’re gonna get lots and lots of poor people and no rich people.

This doctrine is part of a wider set of ideas known as supply side economics, which emphasises that prosperity emerges when the government does least and allows the market the freedom to express itself most fully.

This revival of free market ideas has defined government policy on both sides of the Atlantic since the late 1970s. The facts of the matter however, contradict the claims made by the likes of Laffer and Milton Friedman. If trickle-down were working—if the poorest in society were being dragged up by the richest becoming more affluent, as Margaret Thatcher declared would be the case—it should mean that we are all getting richer (per capita). We are not, though.

Despite the usual dichotomy of ‘growth-enhancing pro-rich policy’ and ‘growth-reducing pro-poor policy’, pro-rich policies have failed to accelerate growth in the last three decades. So the first step in this argument – that is, the view that giving a bigger slice of pie to the rich will make the pie bigger – does not hold.

The second part of the argument – the view that greater wealth created at the top will eventually trickle down to the poor – does not work either. Trickle down does happen, but usually its impact is meagre if we leave it to the market. (Chang, 2011)

Ha-Joon Chang argues in 23 Things… that income and wealth will not trickle down if we leave the market to its own devices. The economic growth generated through tax breaks and freer markets requires government redistribution, or the poorest in society will not get any richer.

As it happens, the bailing out of the financial sector and the ensuing austerity in the UK has meant that GDP per capita (average earnings) has still not recovered to pre-2008 levels. And according to (Table 2 of) Credit Suisse’s Global Wealth Report 2014, the UK is the only member of the G7 where wealth inequality has increased since 2000.

The amount of the [UK’s] controlled by the richest 10% increased to 54.1% [in 2014], up from 51.5% in 2000 … [Meanwhile, the] increase in inequality has coincided with a boom in the number of rich and super-rich people in Britain. (Treanor & Farrell, 2014)

The picture is not a lot different across the pond. While the wealth share of the top ten per cent in the US has not increased since 2000, the gains from its economic growth are not being shared equally. The Washington Post reported in October 2014 that:

adjusted for household size, real median incomes haven’t increased at all since 1999. That’s right: the middle class hasn’t gotten a raise in 15 years … [and it] is poorer, too. Median net worth is actually lower, adjusted for inflation, than it was in 1989. Even worse, it’s kept falling during the recovery.

We can see therefore, that, instead of economic growth—the rising tide that was supposed to lift all boats—benefiting all equally, decades of tax cuts for the richest and fiscal austerity for the poorest has just made the richest richer. What this means is a worrying new trend in some parts of the west.

The lifestyle that the average earner had half a century ago—reasonably sized house, dependable healthcare, a decent education for the children and a reliable pension—is becoming the preserve of the rich … The economies of Britain and America may now be transforming into the same hourglass shape that once characterised those of emerging countries. (West & Nelson, 2013)

DROWNING THE MIDDLE CLASS
The problem, according to internet billionaire Nick Hanauer, is that we have had too much faith in trickle-down, too much belief that inequality would benefit us all … when in fact, too much inequality threatens capitalism itself:

Trickle down economics is as old as human civilization. We used to call it divine right … It’s simply the idea that I matter and you don’t. That what I do is indispensable and what you do is extra. It’s how we keep you in line.

No matter how much money I have, I cannot sustain a great national economy – only a robust middle class can do that … Capitalism, which is the greatest social technology ever created for creating prosperity in human societies does need some inequality, just like plants do need some water. But in precisely the same way that too much water kills plants by drowning them, too much inequality kills capitalism by drowning the middle class.

The middle class is vital to the health of the wider economy, Thomas Piketty tells Peretti, because it enables mass investment and mass consumption (which have been shrinking over the past few decades). If the gulf in income and wealth between the richest and poorest continues to grow he argues, the future of democratic society itself could be threatened.

TRICKLE-UP
The incomes and wealth of the super-rich in Anglo-American economies have been growing much faster than has been the case for the average. This has put a great deal of pressure on the section of society that we have come to know as the middle class – so much so that we may be witnessing its decline.

Elizabeth Warren’s interpretation of Piketty’s Capital was that it showed that: “wealth does not trickle down. It trickles up. It trickles from everyone else to those who are rich.” As Peretti puts it, we’ve reached a stage where the super rich have the money and we need it.

A GLOBAL ANNUAL TAX
We need meaningful redistribution then, but what form should this take? In Piketty’s view:

It would be better actually, to have an annual tax on wealth. This is just a matter of common sense … When you have booming property values at the top end and booming top wealth portfolios at the top end, it would be crazy not to ask for a little bit more.

The ideal tool, for Piketty, would be a global tax on capital, coupled with greater financial transparency among nations. This is not going to be straightforward, he admits (due to the considerable level of international cooperation it requires), but he proposes this as ‘a useful utopia’ – useful in the sense that it may provide a reference point by which we can assess our progress.

We do not need to (nor could we) start at a global tax. It is enough to start at the regional level (the European Union, for instance) and work onwards from there. Further, many nations have already attempted similar taxes on capital, such as France—which has levied the so-called solidarity tax on wealth—though Piketty notes that this is riddled with loopholes.

It’s important to note that such a tax would not be designed not as a way of funding welfare states or replacing all other forms of taxation. Even if levied at a very small rate, such as 0.1 per cent, there would be benefits, economic and otherwise; the main purpose would be to rein in the destructive power of unregulated capital.

A 0.1 per cent tax on capital would be more in the nature of a compulsory reporting law than a true tax … It is important to understand that a tax is always more than just a tax: it is also a way of defining norms and categories and imposing a legal framework on economic activity. This has always been the case, especially in regard to land ownership. (Piketty, 2014: 519)

We currently rely on Forbes magazine for estimates of the distribution of wealth. A tax such as this would give us reliable information that governments could use to more effectively deal with financial crises and plan for the future of social spending.

There is no need, for instance, to resort to depositor “haircuts” (which actually amounted to the confiscation of thousands from ordinary individuals) as Cyprus did in financing its end of the bailout deal agreed with the EU and the IMF in 2013. There is also no need for austerity such as that in the UK which has hurt the least well off most. Greater international financial transparency in this way translates into greater accountability with regards to fiscal and social reforms.

INSTITUTIONS FOR THE TWENTY-FIRST CENTURY
The major results of Piketty’s study show that we should not be complacent about the nature of capitalism. While there are inherent forces within it that push it towards greater equality (the diffusion of knowledge and technology which enables countries such as China and South Korea to develop rapidly, for instance), there are also forces inherent within it pushing it towards greater inequality. The most basic ‘force for divergence’ as Piketty puts it, is a state of affairs where earnings on capital are allowed to outstrip economic growth (where r > g).

We need institutions and policies—beyond the twentieth century’s fiscal and social model—which counter this ‘implacable logic’ towards greater inequality and we must be willing to bring about the political integration needed to make them a reality.

If democracy is someday to regain control of capitalism, it must start by recognizing that the concrete institutions in which democracy and capitalism are embodied need to be reinvented again and again. (Ibid.: 570)

A RADICAL?
Piketty distances himself from Marx’s apocalyptic conclusions but warns that without sufficient change ‘the possibilities are not heartening’ (Ibid.: 27). Nevertheless, there is room for a reasonable level of optimism, he suggests. Beyond the diffusion of technology and skills, there are also labour market institutions that can be a force for greater convergence (reduced inequality).

Peculiarly, he notes, the national minimum wage in the US remains lower now in real terms than it was in the 1960s – this can be changed. There may also be a greater push towards unionisation as a means of protecting the livelihoods of workers and with any luck, fighting the senselessly out of proportion salaries and bonuses of today’s class of super-managers.

Piketty says that he’s “not terribly impressed” by those that profess to know what will happen in advance of the levying of taxes on capital, because much the same was prophesied of income taxes roughly a century ago, which have turned out to be a massive success.

What Piketty has captured, regardless, is that we have reached a critical point in economic development where the effects of capital on economic development need to be restrained by democratic means … or as he warns, we could have a return to the toxic politics of the 1930s and 1940s.

Piketty is not wrong to suggest that significant fiscal change is needed and he deserves a great deal of credit for putting inequality back on the agenda. There’s been a remarkable complacency among mainstream economists and policymakers since around 2010, since which it’s been assumed that the problems uncovered by the recent financial crisis have basically been dealt with. They have not and inequality remains a menace.

Many on the political right see Piketty’s proposals as too extreme and have been looking for anything they can to undermine him (Chris Giles has tried harder than most). I believe, however, that history will show Piketty to be a moderate. As he rightly argues, his proposal of (something approaching) a global tax on capital is a lot better than some of the alternatives we saw in the last century that may yet re-emerge: a widespread and prolonged protectionist spiral, or worse, the re-emergence of totalitarianism.

The lack of this kind of response is what has so far distinguished the Great Recession from the Great Depression and the recent rise in support for parties on the political far right in Europe warrants anything but the faith in the market espoused by many of Piketty’s detractors.

Elizabeth Warren insists that we have to have a debate (and we do) on economic rewards. Should it be those that work hard that are rewarded best or should it continue to be rentiers, those that essentially earn money for nothing? In the final analysis, Piketty deserves a great deal of credit for expressing the defining issue of our time in a manner that forces the economics profession to face something it would so much prefer to ignore.

Do Rich People Deserve to Be Rich?

One of our abiding modern myths, as Russell Brand and George Monbiot explained in a recent episode of the Trews is: “that if you’re rich, you deserve to be rich and that story means that if you’re not rich, you don’t deserve to be rich and that means everything’s the way that it should be and nothing should change.”

This is what Melvin Lerner described as the just-world hypothesis. We have an in-built bias which makes us view the world as fundamentally just and the basic reason it exists is to make us feel more secure in ourselves as we go about our daily lives. What this means however, is that we are prone to errors in judgement such as what Monbiot refers to as the self-attribution fallacy and what psychologists often refer to as the fundamental attribution error. In essence, we not only overestimate the extent to which our successes are down to ourselves alone – we also often take credit for things we didn’t do.

This matters because in this day and age, we believe that we live in a pure meritocracy and that as such, our outcomes in life are down to our own hard work alone. This belief is deeply ingrained within our social psyche and forms the basis of the way in which some of those with the highest incomes justify earning so much while reserving the right to avoid tax. This kind of attitude leads us as a society to, for example, believe that tax cuts disproportionately affecting the disabled and the poorest in society are fine both inherently and as a means of reducing the budget deficit. In the grand scheme of things, this kind of attitude is at the heart of how we justify—and exacerbate—today’s vast social and economic inequalities.

What I’m going to argue here is that Brand and Monbiot have hit the nail on the head: it’s stupid to attribute your success in life to yourself alone. That’s to say: rich people don’t deserve to be rich (or at least, not as rich as they are – especially the super-rich).

This is the first in a series of posts in which I’ll be looking at (ir)rationality, meritocracy and inequality. In this post in particular, I’ll be explaining, with reference to the writings of Daniel Kahneman and Thomas Piketty, why our modern conceptions of meritocracy do more harm than good and segueing into the next post on what can be done about the inequalities that result. So then…

…WHAT DO WE MEAN BY MERITOCRACY?
I’m going to be borrowing fairly heavily from Piketty’s Capital in the Twenty-First Century (as well as Kahneman’s writing later) throughout, because he captures the essence of the issues I’m writing about here. Firstly:

Our democratic societies rest on a meritocratic worldview, or at any rate a meritocratic hope, by which I mean a belief in a society in which inequality is based more on merit and effort than on kinship and rents … [That is, in a democracy,] inequalities must be just and useful to all, at least in the realm of discourse and as far as possible in reality as well. (Piketty, 2014: 422)

[However,] in the United States, France, and most other countries, talk about the virtues of the national meritocratic model is seldom based on close examination of the facts. Often the purpose is to justify existing inequalities while ignoring the sometimes patent failures of the current system. (Ibid.: 487)

INHERITANCE, INEQUALITY AND A DIGNIFIED LIFE
Nineteenth-century literature is alluded to quite often in Piketty (2014) and provides a useful backdrop for his discussion on inequality. As we’ve established above, democratic society has to at the very least, pay lip service to meritocracy (that is, virtuous and justified inequality).

Interestingly, nineteenth-century novelists … often give a very concrete and intimate account of how people lived [… and sometimes] this went along with a certain justification of extreme inequality of wealth … Notwithstanding the extravagance of some of their characters, [they] describe a world in which inequality was to a certain extent necessary … without a fortune it was impossible to live a dignified life. (Piketty, 2014: 415-16)

Piketty (Ibid.) credits these novelists for not describing this view of theirs as meritocratic, if nothing else, because what contrasts the likes of Austen and Balzac from the likes of Greg Mankiw however, is that the latter does just that.

It is interesting to note that the most ardent meritocratic beliefs are often invoked to justify very large wage inequalities … The most worrisome aspect of this defense of meritocracy is that one finds the same type of argument in the wealthiest societies, where Jane Austen’s points about need and dignity make little sense. In the United States in recent years, one frequently has heard this type of justification for the stratospheric pay of supermanagers (50–100 times average income, if not more) (Ibid.: 417)

The vast social and economic inequalities we have today cannot be justified as those of the nineteenth century were, because, as Piketty explains, while back then a dignified life required an income (or a fortune) far in excess of average earnings—due to the prohibitive costs of travel, food preparation and all the other conveniences civilised life demands—these days, all of that is much, much more affordable. To a large degree then, modern inequalities are useless in comparison.

PAYING FOR LUCK
Not only then does modern (Anglo-American) society have no right to be so unequal, the justifications for the disparities in earnings and wealth put forward by today’s 1% are found wanting as well. Both Piketty and Kahneman are in agreement with Monbiot on the fact that our thinking is often faulty and on the damage that results from not accounting for these biases in our policy-making.

The most convincing proof of the failure of corporate governance and of the absence of a rational productivity justification for extremely high executive pay is that when we collect data about individual firms (which we can do for publicly owned corporations in all the rich countries), it is very difficult to explain the observed variations in terms of firm performance.

If executive pay were determined by marginal productivity, one would expect its variance to have little to do with external variances and to depend solely or primarily on nonexternal variances.

In fact, we observe just the opposite: it is when sales and profits increase for external reasons that executive pay rises most rapidly. This is particularly clear in the case of US corporations: Bertrand and Mullainhatan refer to this phenomenon as “pay for luck.” (Ibid.: 334-35)

AN ILLUSION OF SKILL
The standard theory of how the stock market works, Kahneman explains in Thinking, Fast and Slow, is that share prices follow a random walk; there is no reason or rhyme to the movements of stock prices. This is consistent with the (strong form of the) efficient markets hypothesis, which holds that share prices embody all the information available on the market and that as such, it’s not possible that they are wrong enough that one could systematically outdo the market. And yet, when buyers and sellers of shares participate on the stock exchange, they are aiming to do just this – show that market prices are wrong. Kahneman goes on to explain that:

Mutual funds are run by highly experienced and hardworking professionals who buy and sell stocks to achieve the best possible results for their clients. Nevertheless, the evidence from more than fifty years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker … The successful funds in any given year are mostly lucky; they have a good roll of the dice. There is general agreement among researchers that nearly all stock pickers, whether they know it or not—and few of them do—are playing a game of chance. (Kahneman, 2011)

Some time ago, Kahneman had the chance to study the illusion of financial skill up close. Addressing a group of investment advisers whose performance he had assessed, he explained the extent of this illusion.

No one in the firm seemed to be aware of the nature of the game that its stock pickers were playing. The advisers themselves felt they were competent professionals doing a serious job, and their superiors agreed.

On the evening before the seminar, Richard Thaler and I had dinner with some of the top executives of the firm, the people who decide on the size of bonuses. We asked them to guess the year-to-year correlation in the rankings of individual advisers. They thought they knew what was coming and smiled as they said “not very high” or “performance certainly fluctuates.” It quickly became clear, however, that no one expected the average correlation to be zero. Our message to the executives was that, at least when it came to building portfolios, the firm was rewarding luck as if it were skill. This should have been shocking news to them, but it was not. (Ibid.)

What Kahneman’s account shows is the breathtaking extent to which we are cognitively biased. We are prone not only to be overconfident about our capacity to control and change our circumstances, we also see skill where it is in fact luck that is operating. As Monbiot explained, we are programmed to think in this way and as Piketty explained, this kind of thinking, when we are not vigilant, can lead to vast disparities in incomes and life opportunities. Kahneman continues that:

There was no sign that they disbelieved us. How could they? After all, we had analyzed their own results, and they were sophisticated enough to see the implications, which we politely refrained from spelling out. We all went on calmly with our dinner, and I have no doubt that both our findings and their implications were quickly swept under the rug and that life in the firm went on just as before.

The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions—and thereby threaten people’s livelihood and self-esteem—are simply not absorbed. The mind does not digest them. This is particularly true of statistical studies of performance, which provide base rate information that people generally ignore when it clashes with their personal impressions from experience. (Ibid.)

While ordinarily, when confronted with evidence of say, optical illusions, we are content to modify our responses based on our new knowledge, in the case of cognitive biases, we find it much harder (if not impossible) to do so.

We know that people can maintain an unshakable faith in any proposition, however absurd, when they are sustained by a community of like-minded believers. Given the professional culture of the financial community, it is not surprising that large numbers of individuals in that world believe themselves to be among the chosen few who can do what they believe others cannot. (Ibid.)

The just-world phenomenon is not only problematic because of our inherent cognitive biases. One of the other major problems with the myth that society as we have it is fair and just is that it doesn’t account for the extent to which success hinges on arbitrary factors, such as inheritance.

LORD ROTHERMERE AND LILIANE BETTENCOURT
Returning to Brand and Monbiot’s discussion then, to what extent is inheritance rather than hard work responsible for the success of the richest in today’s society?

Lord Rothermere, what he brilliantly done is, he came out of the vagina of this lady who was married to a person whose name was also Lord Rothermere. And that meant that he got a thing called a Daily Mail, a newspaper, given to him. (Brand, The Trews 223)

The main thesis of Piketty (2014) is that when earnings on capital (r) exceed the rate of economic growth (the speed at which output and incomes rise) (g)—that is, when r > g—as was the case in the nineteenth century and is increasingly so in this century, arbitrary (rather than truly justified) inequalities result. This gulf in standards of living serves only to undermine the fabric of democratic society.

While people tend to believe that the age of inheritance is now over, or at least has little prominence, examination of the data show why we should remain vigilant:

One of the most striking lessons of the Forbes rankings is that, past a certain threshold, all large fortunes, whether inherited or entrepreneurial in origin, grow at extremely high rates, regardless of whether the owner of the fortune works or not.

In other words, Liliane Bettencourt, who never worked a day in her life, saw her fortune grow exactly as fast as that of Bill Gates, the high-tech pioneer, whose wealth has incidentally continued to grow just as rapidly since he stopped working. Once a fortune is established, the capital grows according to a dynamic of its own, and it can continue to grow at a rapid pace for decades simply because of its size. (Piketty, 2014: 439-40)

While we are led to believe that our own efforts are sufficient to yield a living income, in an age where r > g, this is becoming less true by the day. Capital, it bears repeating, grows according to a dynamic of its own. While we are led to believe that:

you are on your own and what you achieve is down to you and if you don’t achieve, that’s your fault – and don’t expect us to pick up the pieces… (Brand, The Trews 223)

…Piketty shows that inequalities are increasingly less down to our own actions and owe more to the particular way in which capital accumulates on its own.

People with inherited wealth need save only a portion of their income from capital to see that capital grow more quickly than the economy as a whole. Under such conditions, it is almost inevitable that inherited wealth will dominate wealth amassed from a lifetime’s labor by a wide margin, and the concentration of capital will attain extremely high levels—levels potentially incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies. (Piketty, 2014: 26)

PSYCHOPATHS IN BUSINESS AND MERITOCRATIC EXTREMISM
On a related note, there genuinely are special qualities that distinguish some of the most successful in business to the rest of us, Monbiot explains – such as the extent to which corporate executives behave like psychopaths. Some of those highest up in British industry today are actually more psychopathic than the average psychopath in Broadmoor Hospital!

We’ve built a society that rewards psychopaths! … On an individual level, we’re encouraged to be selfish and greedy … the apotheosis of that is psychos running our businesses and ultimately, our society is an echo of that madness. (Brand, The Trews 223)

This, right here, is the most damning criticism of what Piketty refers to as meritocratic extremism (by which he means):

the apparent need of modern societies, and especially US society, to designate certain individuals as “winners” and to reward them all the more generously if they seem to have been selected on the basis of their intrinsic merits rather than birth or background (Piketty, 2014: 334)

The perpetuation of the myths of a just-world, of individualism, the insistence that we don’t have duties to each other, the insistence that the successful must be rewarded handsomely (paradoxically, even when they fail) – all this leads to exactly the kind of vastly unequal society that we currently have in the Anglo-American west, where hyper-psychopathic behaviour is held up as the model way to conduct oneself.

SO WHAT CAN WE DO ABOUT THIS FINE MESS?
What we can learn from Kahneman’s Thinking, Fast and Slow—and behavioural economics in general—is that while in professional life most people are highly skilled and rational, we overestimate the extent to which we are.

We do this for a number of reasons. Partly it’s down to culture, which can make even patently false ideas appear to be eminently wise. We must also remind ourselves that we are human and as such, we are deeply flawed. Social psychologists have known since at least 1970 that we routinely confuse external causation (or situational factors) for internal causation (or dispositional factors). That is, we take credit for things that we did not do. We behave this way in order to protect our egos because often, the truth is too much to bear.

In terms of a policy response to the inequalities that result, according to Piketty:

There are nevertheless ways democracy can regain control over capitalism and ensure that the general interest takes precedence over private interests, while preserving economic openness and avoiding protectionist and nationalist reactions. (Ibid.: 1)

We cannot rely on economic growth (growth in output and incomes) alone to make democratic society fairer because history shows us that high rates of growth manifest themselves only rarely (in the case of countries still in the process of industrialisation and in post-war periods). What we have to do then, is tax capital in a progressive way and as far as possible, on a global scale.

In the rest of this series, I’ll be looking in more detail at what we can do to remedy today’s inequalities and trying to get to the bottom of what it is that really makes us successful to the degree that we are. Because, as George Monbiot puts it, “if wealth was the inevitable result of hard work and enterprise, every woman in Africa would be a millionaire”. There’s a lot more to (financial) success than meets the eye.

Rethinking the Definition of “Public Goods”

Real-World Economics Review Blog

from June Sekera

Introduction

A year ago last May, the Real World Economics Review blog published my post, “Why Aren’t We Talking About Public Goods?” In that article I argued that we need to revive and reframe the concept of public goods. A concept of public goods is immensely important because: 

  • The absence of a widely-held, constructive idea of public goods in public discourse denies citizens the ability to have an informed conversation, or to make informed decisions, about things that matter mightily to the quality of their lives and their communities.
  • Its absence robs public policy makers, leaders and managers of the concept that is most central to the reason for their being. 
  • The current economics definition of public goods feeds and supports the marketization and privatization of government, and the consequent undermining of governments’ ability to operate.         

Since last May I have met with economists…

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