Category Archives: Banking

The Ideology of Self-interest Caused the Financial Crash. We Need a New Economic Paradigm

By Mark van Vugt and Michael E. Price – We are still feeling the effects of the global financial crisis, which started in the US in 2008, and that has now spread to every corner of the world.

The financial crisis should teach us some important lessons about the way economies work and the way we design our organizations. In essence, we have simply made the wrong assumptions about human nature. The leading model in economic theory is that of Homo economicus, a person who makes decisions based on their rational self-interest. Led by an invisible hand, that of the market, the pursuit of self-interest automatically produces the best outcomes for everyone. Looking at the financial crisis today this idea is no longer tenable. When individual greed dominates, everyone suffers. We could have known this all along had we looked more closely at human evolution.

Economic scientists often portray competition between firms as a Darwinian struggle where firms compete and only the fittest ones survive. The British financial historian Niall Ferguson wrote “Left to itself, natural selection should work fast to eliminate the weakest institutions in the market, which typically are gobbled up by the successful.”

This may be true but it is not the outcome of individual greed and competition.

Competition between firms presupposes that individuals cooperate well with each other, and the most cooperative organizations survive, and the least cooperative organizations go extinct. This is group selection, selection operating at the level of groups, where the best groups survive.

This is a far more accurate model of how economies and business operate, and it offers a totally new way of thinking about the design of organizations and ways to avert global financial crises.

A team of evolutionary minded psychologists, biologists and economists led by biologist David Sloan Wilson have come together over the past few years to come up with a more accurate model for how businesses and economies operate. It is based on Homo sapiens rather than Homo economicus. Their efforts are put together in an Evolution Institute report on socially responsible businesses “Doing Well By Doing Good.” more>

Takers and Makers: Who are the Real Value Creators?

By Mariana Mazzucato – We often hear businesses, entrepreneurs or sectors talking about themselves as ‘wealth-creating’. The contexts may differ – finance, big pharma or small start-ups – but the self-descriptions are similar: I am a particularly productive member of the economy, my activities create wealth, I take big ‘risks’, and so I deserve a higher income than people who simply benefit from the spillovers of this activity. But what if, in the end, these descriptions are simply just stories? Narratives created in order to justify inequalities of wealth and income, massively rewarding the few who are able to convince governments and society that they deserve high rewards, while the rest of us make do with the leftovers.

If value is defined by price – set by the supposed forces of supply and demand – then as long as an activity fetches a price (legally), it is seen as creating value. So if you earn a lot you must be a value creator.

I will argue that the way the word ‘value’ is used in modern economics has made it easier for value-extracting activities to masquerade as value-creating activities. And in the process rents (unearned income) get confused with profits (earned income); inequality rises, and investment in the real economy falls.

What’s more, if we cannot differentiate value creation from value extraction, it becomes nearly impossible to reward the former over the latter. If the goal is to produce growth that is more innovation-led (smart growth), more inclusive and more sustainable, we need a better understanding of value to steer us.

This is not an abstract debate.

It has far-reaching consequences – social and political as well as economic – for everyone. How we discuss value affects the way all of us, from giant corporations to the most modest shopper, behave as actors in the economy and in turn feeds back into the economy, and how we measure its performance. This is what philosophers call ‘performativity’: how we talk about things affects behavior, and in turn how we theorize things. In other words, it is a self-fulfilling prophecy.

If we cannot define what we mean by value, we cannot be sure to produce it, nor to share it fairly, nor to sustain economic growth. The understanding of value, then, is critical to all the other conversations we need to have about where our economy is going and how to change its course. more>

A radical legal ideology nurtured our era of economic inequality

By Sanjukta Paul – Where does economic power come from? Does it exist independently of the law?

It seems obvious, even undeniable, that the answer is no. Law creates, defines and enforces property rights. Law enforces private contracts. It charters corporations and shields investors from liability. Law declares illegal certain contracts of economic cooperation between separate individuals – which it calls ‘price-fixing’ – but declares economically equivalent activity legal when it takes place within a business firm or is controlled by one.

Each one of these is a choice made by the law, on behalf of the public as a whole. Each of them creates or maintains someone’s economic power, and often undermines someone else’s. Each also plays a role in maintaining a particular distribution of economic power across society.

Yet generations of lawyers and judges educated at law schools in the United States have been taught to ignore this essential role of law in creating and sustaining economic power.

Instead, we are taught that the social process of economic competition results in certain outcomes that are ‘efficient’ – and that anything the law does to alter those outcomes is its only intervention.

These peculiar presumptions flow from the enormously powerful and influential ‘law and economics’ movement that dominates thinking in most areas of US law considered to be within the ‘economic’ sphere.

Bruce Ackerman, professor of law and political science at Yale University, recently called law and economics the most influential thing in legal education since the founding of Harvard Law School.

The Economics Institute for Federal Judges, founded by the legal scholar Henry Manne, has been a hugely influential training program in the law and economics approach. more>

The world is running out of time

By Bertrand Badré – In 2015, the international community launched a renewed effort to tackle collective global challenges under the auspices of the United Nations Sustainable Development Agenda and the Framework Convention on Climate Change (COP21). But after an initial flurry of interest, the progress that has been made toward achieving the Sustainable Development Goals and tackling climate change has tapered off. Around the world, many seem to have developed an allergy to increasingly stark warnings from the UN and other bodies about accelerating species extinctions, ecosystem collapse, and global warming.

Now is not the time to debate whether progress toward global goals is a matter of the glass being half-full or half-empty. Soon, there will no longer even be a glass to worry about. Despite global news coverage of civic and political action to address our mounting crises, the underlying trends are extremely frightening.

For decades, most of the major economies have relied on a form of capitalism that delivered considerable benefits. But we are now witnessing the implications of the Nobel laureate economist Milton Friedman’s famous mantra: “the social responsibility of business is to increase its profits.”

A corporate-governance model based on maximizing shareholder value has long dominated our economic system, shaping our accounting frameworks, tax regimes, and business-school curricula.

But we have now reached a point where leading economic thinkers are questioning the fundamentals of the prevailing system. Paul Collier’s The Future of CapitalismJoseph E. Stiglitz’s People, Power, and Profits, and Raghuram G. Rajan’s The Third Pillar all offer comprehensive assessments of the problem.

A capitalist system that is disconnected from most people and unmoored from the territories in which it operates is no longer acceptable. Systems do not work in isolation. Eventually, reality asserts itself: global trade tensions reemerge, populist nationalists win power, and natural disasters grow in frequency and intensity.

Simply put, our approach to capitalism has exacerbated previously manageable social and environmental problems and sowed deep social divisions. The explosion in inequality and the laser focus on short-term results (that is, quarterly earnings) are just two symptoms of a broken system. more>

Updates from Chicago Booth

How to fight corruption—and why we should
Petty corruption was long thought to grease the wheels of business. But economists are learning how much it can hold back some companies and local economies.
By Rose Jacobs – In the oil, gas, and mining industries, the temptation to pay a bribe can be strong.

Multinational companies that dominate these industries typically agree to pay host countries for the extraction of natural resources, which involves acquiring licenses and setting up agreements that specify the terms of the process and any payments to the host country, including royalties, license fees, and bonuses.

But each company strikes its own deal with a host country, so why not just pay a bribe in exchange for a more favorable agreement? Some might see it as necessary grease in the wheels of business, the price of getting work done in countries where regulation is lax and bureaucracy the law.

However, research suggests that avoiding bribes might be a good thing—and not just because businesses could get caught and might have to pay fines, such as the $1.78 billion in penalties Brazilian oil-and-gas company Petrobras agreed to pay last year.

Starting in 2013, the European Union and Canada established rules meant to crack down on corruption in the extractive industries, requiring detailed disclosures meant to give activists and other watchdogs the ability to spot signs that corruption may have taken place. Analyzing data in the wake of the anti-corruption measures, researchers find that companies forced to increase their disclosures also increased their official payments to foreign governments, potentially making more money available to the local communities.

Academics have debated for decades whether corruption hampers economic development. In the 1960s through the ’80s, one popular notion was that corruption played a positive role, at least in the developing world. Economists such as Columbia’s Nathaniel H. Leff and political scientists such as the late Samuel P. Huntington of Harvard argued that bribes serve as a means of skirting inefficient bureaucracy, and help to promote economic growth and its many benefits. more>

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Eight Reasons Why Inequality Ruins the Economy

What matters is not so much the level of inequality as the effect it has.
By Chris Dillow – Roland Benabou gave the example (pdf) of how egalitarian South Korea has done much better than the unequal Philippines. And IMF researchers have found (pdf) a “strong negative relation” between inequality and the rate and duration of subsequent growth spells across 153 countries between 1960 and 2010.

Correlations, of course, are only suggestive. They pose the question: what is the mechanism whereby inequality might reduce growth? Here are eight possibilities:

1. Inequality encourages the rich to invest not innovation but in what Sam Bowles calls “guard labor” (pdf) – means of entrenching their privilege and power. This might involve restrictive copyright laws, ways of overseeing and controlling workers, or the corporate rent-seeking and lobbying that has led to what Brink Lindsey and Steven Teles call the “captured economy.

An especially costly form of this rent-seeking was banks’ lobbying for a “too big to fail” subsidy. This encouraged over-expansion of the banking system and the subsequent crisis, which has had a massively adverse effect upon economic growth.

3. “Economic inequality leads to less trust” say (pdf) Eric Uslaner and Mitchell Brown. And we’ve good evidence that less trust means less growth.

One reason for this is simply that if people don’t trust each other they’ll not enter into transactions where there’s a risk of them being ripped off.

5. Inequality can cause the rich to be fearful of future redistribution or nationalization, which will make them loath to invest. National Grid is belly-aching, maybe rightly, that Labour’s plan to nationalize it will delay investment. But it should instead ask: why is Labour proposing such a thing, and why is it popular? more>

The free market is not the answer

By Jochen Steinhilber – We are discussing the digital transformation, which will profoundly change how we live, work and participate in politics and society in the decades to come.

The political and social significance of digital networking, smart factories and big data depends on how technology is used. It can deepen social inequalities and cement domination and profit maximization, or it can improve working and living conditions and facilitate participation. That is why digitalization needs political direction and should be based on social agreements.

But how can this be achieved without, for example, bringing those companies under tighter democratic control that, for many years, have been engaged in secret negotiations on international trade policy to ‘protect’ the digital and services agenda from all state intervention for years to come?

Also, those who will rightly champion the ecological transformation in the coming years and want to pursue it in a maximally inclusive way will have to ask themselves how this can be achieved under the current relations of power between the economy, politics and democracy—especially under lower growth rates that allow less space for redistribution.

Anyone who now claims that, considering the challenges of climate protection, a debate on economic democracy is a diversionary tactic and at best of theoretical rather than political interest, ignores the fact that the important strategic decisions must be taken at the economic level.

Do we really want to leave crucial questions—where can growth continue because it serves the common good? what must be dismantled because it is ecologically and socially harmful? and who pays for the change?—for the most part to the dominant market players?

And finally, the frequently-invoked crisis of democracy at least suggests that we need to rethink how the economy works. more>

Too much theory leads economists to bad predictions

By Peter A Coclanis – In economics, as a result, both economic history and (especially) the history of economic thought withered for a generation or two.

So what accounts for the recent change of course? For starters, there was the Great Recession – or ‘Lesser Depression’, as Krugman called it in 2011 – which seemed to a few influential economists such as Ben Bernanke, Carmen Rinehart, Ken Rogoff and Barry Eichengreen similar in many ways to other financial crises in the past. But there were other factors too, including the general retreat from globalisation, and the renascence of both nationalist and authoritarian movements around the world, which sounded the death knell for Fukuyama’s benign new world.

As ‘history’ returned, so too has a degree of acceptance of historical approaches among social scientists, who sense, however vaguely, that though history might not repeat itself, it often rhymes, as Mark Twain (might have) put it.

Thinking historically, of course, entails both temporal and contextual dimensions and, in addition, often requires a significant amount of empirical work. Indeed, finding, assembling, analysing and drawing accurate conclusions from the bodies of evidence that historians call data is not for the weak of heart or, more to the point, for those short of time.

So, bottom line: economic forecasters would profit from thinking a bit more about history before gazing into their crystal balls, or at least before telling us what they see. more>

Inequality: from redistribution to predistribution and beyond?

Soaring income inequality inevitably raises discussion of more progressive taxation. But a more fundamental focus on the ownership of capital is needed.
By Liam Kennedy – The now much-traveled line from the historian Rutger Bregman at Davos 2019 is a perfect encapsulation of the Zeitgeist: inequality is out of control, we know more or less how to reduce it but, instead of actually doing anything, here we are pretending to be baffled by the state of the world.

Outside those snow-capped peaks, there is, of course, widespread recognition of the need to tackle spiraling inequality. The Organisation for Economic Co-operation and Development has spoken about it, the International Monetary Fund has written about it and reducing inequalities is enshrined in the United Nations Sustainable Development Goals.

Unfortunately, this evidence does not always translate into coherent political action. In the United Kingdom, for example, top rates of income tax have become less progressive over the decades while corporation tax has been consistently cut since 2010. Acknowledging the inequality problem is a crucial first step—but there is also a strong case for looking beyond ‘taxes, taxes, taxes’ if it is to be truly tackled.

Additionally, UK income-inequality statistics are plagued with problems which militate against any consistent understanding of how much income those at the very top of the distribution are actually ‘earning’.  To put it bluntly, the rich are even richer than we realize.

The truth is that the initial fall in income inequality seen after the financial crisis was an aberration which has allowed the government to mask the more systemic and continuing rise in inequality the UK has experienced since the late 1970s. more>

Green money without inflation

Funding an ecological transition in Europe via ‘green money’ bonds would be economically justifiable.
By Paul De Grauwe – To what extent can the money created by the central bank be used to finance investments in the environment?

This is a question often asked today. The green activists respond with enthusiasm that the central bank—and, in particular, the European Central Bank (ECB)—should stimulate the financing of environmental investments through the printing of money.

The ECB has created €2,600 billion of new money since 2015 in the context of its quantitative easing (QE) program. All that money has gone to financial institutions which have done very little with it. Why can’t the ECB inject the money into environmental investments instead of pouring it into the financial sector?

Most traditional economists react with horror.

Who is right? It is good to recall the basics of money creation by the ECB (or any modern central bank). Money is created when that institution buys financial assets in the market. The suppliers of these assets are financial institutions. These then obtain a deposit in euro at the ECB, in exchange for relinquishing these financial assets. That is the moment when money is created. This money (deposits) can then be used as their reserve base by the financial institutions to extend loans to companies and households.

There is no limit to the amount of financial assets the ECB can buy.

In principle, it could purchase all existing financial assets (all bonds and shares, for example), but that would increase the money supply in such a way that inflation would increase dramatically. In other words, the value of the money issued by the ECB would fall sharply. To avoid this, the bank has set a limit: it promises not to let inflation rise above 2 per cent. That imposes a constraint on the amount of money which the ECB can create. So far, it has been successful in remaining within the 2 per cent inflation target. more>