Is this a failure of democracy?

The continuing crisis in the Euro zone, framed by a series of meetings that seem to never come to a conclusion, has many people asking whether government, or more broadly democracy, has failed (as Prof Ngaire Woods discussed in a recent radio interview). The narrative goes something like this - the markets need clear signals and strong action, government cannot provide them with these actions or they do not wish to do so as the actions that are needed are politically unpalatable. So this is now a failure of government, of the system of democracy, as we are seeing the limits of what can be done via the political process.

This for me is completely wrong headed - what we are seeing is a failure of our combined system of governance, including the public and the private sector. There is no public sector without a private sector, and no matter what some libertarians would have you believe, there is no private sector without the public sector. Markets are embedded in social structures and to try to claim that they are independent is foolish and in many cases disingenuous.

The past couple of weeks have been hairy for my television, as the risk of something hitting it at speed has been very high. A parade of commentators, valued and promoted on the basis of their expertise as economists whilst ignoring their interest in specific outcomes, claiming that the credit crisis was due to a lack of regulation are happily forgetting the drum beat of no regulation, no government that existed pre the crisis. At the same time many politicians are castigating the evil bankers while forgetting either their campaign contributions or their lack of action on existing regulation. No wonder I see the television shudder when I flick over to Paxman and his sneer.

This is a failure of the business-government relationship, specifically in the financial sector, on a global basis. The narratives of growth and the zealous belief in the end of boom and bust, the death of risk and the boon of every rising incomes, all were built on false foundations. Niall Ferguson's latest op-vid (a horrible term for someone making a speech to camera with some natty supporting animation) hits this nail on the head, turning Clinton's mantra of 'It's the economy stupid' into a more pointed 'It's the stupid economists' (however, his proposed actions are not ones I'd agree with).

There are some industrialists, some economists, some politicians who are trying to move forward, not letting ideology hold them down. But they are a little lost in the cacophony that surrounds the Greek situation, the probable Italian bailout and the continuing problem of stalled growth. Unless we can create the space for a new conversation to occur, for clear thinking and constructive debate to emerge, we won't be able to solve our problems. And that would be the worst failure of our liberal, democratic system.

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Inevitable or not? The return of manufacturing to the US

The credit crisis and the recession have been good at one thing - forcing commentators, researchers and managers to challenge their implicit assumptions about the world. The end of boom and bust, the possibility of having a post-industrial society, and the continued growth of China all have been called into question since 2008.

One of the emerging discussions is on whether manufacturing will 'return' to developed or leading economies such as the United States. While this was not on policy makers' agendas five years ago, the need to find growth is forcing them to look anew at industrial structure and their role in supporting industrial growth.

As this discussion unfolds it is interesting to contrast the positions being taken by various of the writers and commentators. A new report from Boston Consulting Group claims that manufacturing cost advantages will erode between the US and China within five years leading to a rise in manufacturing in the US. Reading it made me think back to the 2009 piece from Pisano and Shi which lamented the loss of the industrial commons in the US and the need for the public and the private sector to engage in rebuilding the foundations of industrial strength in the US. Both can be true but maybe they should be taken together to get a better picture of what might need to be done to support industrial growth in the US.

Looking at the BCG report it does a good job of reminding us of the context for US manufacturing. According to the report, since 1972 manufacturing output has more than doubled in constant dollars and the US share of world manufacturing value added for 2010 is 19.4% compared to 19.8% for China. Without showing their explicit analysis the report claims that rising wages, increasing shipping costs, more expensive land and the strengthening renminbi will mean the cost advantages for China are about to disappear.

"Our analysis concludes that, within five years, the total cost of production for many products will be only about 10 to 15 percent less in Chinese coastal cities than in some parts of the US where factories are likely to be built."

This is a very strong statement and one that really needs to show the background analysis so that it can be critiqued properly. However, there are immediate reasons why this may be too rosy a picture for those hoping for increases in manufacturing in the US. The comparison between the cheapest parts of the US and the most expensive parts of China may mislead, as cheaper options will still exist in China. Also, is this really a total cost model? Have they included the potential actions of state and federal government in the US and in China? While the message may be right overall (arguments about the timescale aside) the model may just be too simple to back up the claims.

Which is what led me back to the Pisano and Shi piece in Harvard Business Review on restoring American competitiveness. The main argument here is that over the past 30 to 40 years as outsourcing of production has risen significantly the US has essentially weakened its industrial commons. Many products can no longer be made in the US as specific knowledge has left the country and has not been retained either in people or companies. The rebuilding of the commons, and possibly more importantly the building of a commons that is appropriate to the needs of the next generation of manufacturing, will be a difficult task that potentially will require much coordination and collaboration between industry and government.

So the mainly cost based analysis of BCG does not appear to admit to the kinds of issues that Pisano and Shi are worried about, the fabric of industry and its ability to adapt and do new things, the skills base of the country and its investment in retaining and improving production processes through strong R&D. This is why I'm wary of big claims like those made in the BCG report, especially when they could potentially lead policy makers to think of the return (increase really) of manufacturing as somehow inevitable. It is not and there are many complexities to be unearthed and overcome before we'll see a significant shift in the structure of the economy and strong growth based on industry in the US or in other developed economies.

Best

Finbarr

The problem of scale

I've been reading Ian Morris' Why the West Rules - For Now over the past couple of weeks (some of the blow by blow in the earlier centuries might have made way to get it down from its 600+ page length) and I've been struck by two things. First the assertion that there have at points in history been barriers or limits to development that have held until conditions or technology moved past a certain limit. And the second is that the problem of scale seems writ large even though it is not really brought out in the text.

The second for me is an integral part of the first and I'm not saying Morris doesn't recognise this or in some ways discuss it. However I thought it was worth making it really explicit. Simply put, big things are not small things made large.

Probably the best piece on this in management literature is the classic 1972 Harvard Business Review article by Larry Greiner Evolution and Revolution as Organizations Grow which discusses the differences between moments of smooth evolution and disruptive revolution based on the age and size of an organization. The idea that the small and the large don't work in the same way is fundamental in physics, in the difference between Newtonian mechanics and the strange world of quantum mechanics (for a musical version of this have a look at the Symphonies of Science the Quantum World).

And in Morris' text what I see lurking is that large countries are not big small countries, if I can mush all of that together. Or to put it another way, the scaling of companies into national economies and from national economies to the global economy involves scaling steps that are discontinuous.

This is very important when trying to understand commentary on the nature of the current recession and the actions that are being taken (or not) to try to reignite growth. How the narrative on how to address the problems is structured depends on what scale you're used to working at. Paul Krugman wrote about this in a direct way in his 1996 piece, again for Harvard Business Review, A Country is Not a Company, where he strongly argued for not following the instincts of CEOs of large companies in terms of economic policy.

It may also point to significant fault lines in economics, between those trying to work up from the microeconomics of companies to the macroeconomics of countries. Maybe, again in parallel to physics, there is no grand theory of everything.

Best

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Industrial policy back in the Economist

At the risk of being a cracked record, countries need to consider industrial policy anew. Interestingly even the Economist is looking at industrial policy arguments and is willing to engage in debate on the issues. A new column discusses recent papers by Rodrik and others being relatively open to the arguments made about positive versus negative paths of innovation. 


However the slight bias for the Economist comes out towards the end ...

In effect, Mr Rodrik and others are arguing that industrial policy requires disinterested, benevolent policymakers who can do it well. Unfortunately, they do not yet have a recipe for how such policymakers can be created. Policy is made by real people with political and personal motivations. What they come up with is unlikely to be as well designed as the ones in the models.

Rodrik has argued elsewhere that industrial policy is an ongoing dialogue and depends on input from industry as much as from policymakers. But I am struck by the argument as it could be reflected into the economy generally. The market is embedded in society, designed and bounded by the laws of each country and a set of norms (those criticised by Ed Milliband in his recent Labour Party conference speech). If policymakers cannot be expected to be perfect designers of industrial policy, let's not assume that financial engineers and captains of industry are perfect decision makers either. 


How can such policymakers be created? Well in the UK a step forward is to provide stronger training, as with the new Blavatnik School of Government opening at Oxford, and to have a more transparent policy process that engages a broad conversation rather than trying to keep everything under the covers. By taking us away from the images of Sir Humphrey and into a more professionalised policy process we can hope for better outcomes.


In the meantime let's be grown up and have a realistic conversation on industrial policy that is not trapped in the tropes of the 80s. 


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The strength of radical doubt

Following the news from CERN that they potentially have an experimental result that destroys a foundation of modern physics I joked that I might have to hand back my physics degree. Obviously the degree doesn't get invalidated just because some pesky particle broke the speed of light, but it did remind me that the radical doubt that physicists carry with them is a strength and not a weakness.

It is a great characteristic of the discipline that when faced with a result that clearly is outside existing models rather than circling the wagons there is a palpable sense of excitement and challenge. It may create a lot of problems and take much time to progress, but it would be one of the greatest times to be a physicist. The opportunity to renew and rewrite a discipline comes around very rarely.

So again I am frustrated by mainstream economics and in particular the use of economics within policy and media debates on the credit crisis and the recovery that has not happened. When the world keeps sending this discipline signals that all is not well, that models and methods do not stand the test of reality, the response is very different to that in physics. Rather than accepting the need to start anew, there is a denial that there is any need for change and renewal.

Until radical doubt and to be honest more humility enters the discipline there is little hope that we can move forward towards a productive version of economics. We live with flat earth economics in a time when we need to be moving faster than the speed of light.

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The tensions of innovation policy in Europe

The Centre for European Reform has released a very interesting collection of pieces on innovation in Europe which highlights all the difficulties in talking about and supporting innovation. It has contributions from John Kay, Maire Geoghegan-Quinn and Amar Bhide amongst others, so does not suffer from a single perspective on the issues.

As discussed here previously, there is continuing confusion over what we all mean by innovation (still!) which is acknowledged in the collection. However according to one of the editors, Philip Whyte, there is a tension between those who study innovation (academics or those in think tanks) and those who have to develop and implement policies in support of innovation (policy makers in general). He claims academics "... point out that Schumpeter's famous description of innovation as a process of 'creative destruction' has two components that are inextricably intertwined. One cannot embrace creation (that is, the emergence of innovative young firms) without accepting destruction (letting uncompetitive incumbents go to the wall). Yet policy-makers ... want innovation, but without the accompanying economic dislocation and social disruption."

I'm not sure that such a tension really exists. Most policy makers understand that firms fail at somewhere about 10% of firms per year in developed economies and that a constant supply of new firms, let alone innovative new firms, is required for growth. Perhaps the policy maker has two roles, to support innovation to occur and to soften some of the transitional pains that come with the changes innovation brings in markets and in society?

Perhaps the biggest problem is one of timescales and incentives - academics have years, policymakers tend to have days. As Sam says in the West Wing "... we play with live ammo around here ..."

A small follow up on the crisis in economics

In my last post I touched on whether there is or there needs to be a crisis within the profession and teaching of economics. As I may have mentioned there seems to be a rumbling noise that many wish to ignore, something in the woodshed that won't go away. This came up again this morning during a panel session at the YouGov-Cambridge Forum 2011, where Vicky Pryce and Lord Griffiths were in conversation with Paul Mason.

In questions I brought up that economics may have failed to train policy analysts and policy makers effectively over the past 20 or 30 years, as macro went into abstract mathematics in an all encompassing way and structural or industrial economics basically was ignored. This didn't really get much traction with Vicky Pryce, but it did beg the question whether economics is now getting in the way of good policy making?

The latest expression of concern about the discipline comes from none other than Paul Krugman and his recent Presidential address to the Eastern Economics Association. There he makes the case that there are three complaints that could be made - that economists did not see the crisis coming, that economists failed by not even considering that such a crisis could occur, and finally that they have failed to provide useful advice in the midst of the ongoing crisis. 

He concludes that the first would be unfair, that the second is substantially true, but that the third is true and is the worst failure. He charges that "We’ve entered a Dark Age of macroeconomics, in which much of the profession has lost its former knowledge, just as barbarian Europe had lost the knowledge of the Greeks and Romans."

As we head towards a double dip and in some eyes potentially a second credit crisis this is not the time for joy in the pain of others. However it is a time when policy makers at the most senior level, whether they come from an economics background or not, to face up to the shortcomings in economic knowledge and practice and to be open to non-dogmatic solutions to the problems of most developed economies. The limits of evidence, knowledge and practice within specifically macroeconomics must be openly acknowledged so that other voices can get into the policy process. Not because we don't like economics, but because we need solutions that work and quick, not more of the same.

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