Tag Archives: economic crisis

What’s the use of economics?

Dr. Diane Doyle runs the consultancy Enlightenment Economics. She is a BBC Trustee and member of the Migration Advisory Committee and of the independent Higher Education Funding Review panel, and was for eight years a member of the Competition Commission (until September 2009). She is also visiting professor at the University of Manchester. She has a PhD from Harvard.

This article is published here in by permission of Vox. (voxeu.org)

Five years after Lehman’s collapse, economics is under fire both from outside and inside the profession for irrelevance, arrogance and more. This column introduces a new Vox debate focused on two questions: What’s the use of economics, and how should we be teaching it to the next generation?

If economics emerges from the Global Crisis unchanged, it will lose all credibility. That is certainly not the view of all economists, but many do think so. There are plenty of examples of criticism of our subject from within and without. Some are ill-informed rants, but others – such as the recent article ‘Economics in Denial’ by Howard Davies (2012), founding chairman of the Financial Services Authority – must be taken seriously.

However, it is not obvious what shape an effective response to even well-founded criticisms could take. After all, engaging in a professional debate about the content and methodology of economics, supported by research, will take years.

One starting point, identified at a conference organized by the Bank of England earlier this year, is the teaching of economics, beginning with the undergraduate level. Participants included both employers of economists (including the Bank and the Government Economic Service) and academic economists. A book with the pre-conference papers and papers by conference participants is published this month (What’s The Use of Economics: Teaching The Dismal Science After The Crisis, London Publishing Partnership).

Feedback from the employers of young economists

Some clear themes have emerged from the conference and the book. One is the extent of employer dissatisfaction with the teaching of economics in universities, for all that economics graduates remain highly employable. Employers of graduates in any subject have some consistent complaints about the lack of certain skills among new graduates, and employers of young economists are no different. For example, the prevalence of poor communication skills is a common theme. Economists working outside the academic world will all need to communicate their technical expertise to non-technical colleagues and customers, so it is a core skill for them. For example, in a 2012 survey of economists in the Government Economic Service – the single biggest employer of economists in the UK – they described the two main areas of their work as the production of briefing material and the preparation of policy advice. City economists and economists in consulting will often have to present research to their firm’s non-economist clients.

Perhaps more surprising is the consistent view among all the employers, as well as some of the academics, that undergraduates need to learn more about both economic history and the history of economic thought, and moreover to be made to pay attention to the economic conjuncture, to economic institutions, to the operation of actual markets in the economy and current policy debates. For instance, as Stephen King, Group Chief Economist at HSBC, put it: “Young economists arrive in the financial world with little or no knowledge of how the financial system operates. This is a matter of collective guilt. Economic models typically assume the financial system is a black box.” Although employers all recognize the need to be realistic about fitting more into the curriculum, and about what a new graduate can reasonably be expected to know, the level of dissatisfaction with current shortfalls is striking.

These gaps in graduates’ knowledge seem not to be due to any lack of interest in economics on their part. In the UK, the number of students beginning an undergraduate degree in economics rose 8.5% to 7,800 in 2011, compared with a 1% rise in the total number of undergraduates, and although the number declined by 2% in 2012, this compared with a 7% decline in the total. The number taking the economics A level has been rising since 2006. It is hard to believe that these figures do not reflect young people’s interest in the dramatic economic events of recent years.

Questions about methodology

A second theme is the way the crisis has given added urgency to some questions or doubts about economic methodology. It is probably true to say that a majority of academic economists do not believe the financial crisis seriously undermines the theoretical framework of their discipline. Even so, a number of participants raised concerns about the emphasis on reductive rather than inductive thinking in economics, and about the use of mathematics without meaning.

Andrew Lo of MIT argues that mathematical techniques in economics only gain meaning from application to actual empirical questions and should be taught in that context. Paul Seabright of the Toulouse School of Economics says students must be taught not that economics is an ever more successful approach to true knowledge about how the economy works, but rather as an empirical investigation of an ever-evolving phenomenon. There was a strong consensus on the need to demote the role of theory and promote empiricism. As Andrew Lo expressed it: “We economists wish to explain 99% of all observable phenomena using three simple laws, like physicists do, but we have to settle instead for ninety-nine laws that explain only 3%, which is terribly frustrating.”

Role of macroeconomics

On the third area, the role of macroeconomics, there was little consensus, but rather a wide array of opinions. These ranged from the view that modest adjustments to the existing models and curriculum would suffice to take account of recent real world economic events, all the way to the more radical view that a new methodological approach to modelling the macroeconomy is required. What to teach on macroeconomics is obviously a secondary question to the current debate about macro analysis (covered in some detail by Simon Wren-Lewis on his blog, for example).

However, when Benjamin Friedman of Harvard describes pre-crisis macro as “wrong headed” and Andrew Haldane of the Bank of England describes representative agent models with expectations reflecting fundamentals as “fundamentally ill-suited” to today’s worlds, it would take someone who is either very confident or very complacent not to reflect some of these doubts in what they teach the next generations of economists.

Changing the teaching of economics courses in universities faces numerous hurdles, and reforming the content of the curriculum may not even be the hardest to overcome. Universities in many countries face financial challenges at present, needing to teach more students with no additional funding. So the demands on academics’ time are increasing. In the UK university system and elsewhere, there are also strong incentives for academics to devote their time to research rather than teaching. What’s more, their research profile and promotion will benefit from their publishing a large number of papers that are incremental to an existing literature. According to academic contributors, the UK’s Research Excellence Framework keeps researchers focused on writing papers, not books, and also on quite a narrow range of journals.

Meanwhile, student surveys suggest many are already rather dissatisfied with the extent of their contact with lecturers or the quality of teaching. In addition, where they face incurring large loans to pay fees, they are becoming more instrumental about their university education: it needs to ensure they do well in their exams and get a good job. Finally, undergraduates are the product of a schooling that has strongly emphasised ‘teaching to the test’ to improve school results in league tables, rather than encouraging intellectual exploration and independent study.

A number of contributors suggest practical steps, not all that time-intensive, to improve undergraduate teaching. Mechanisms for sharing best practice and making use of online resources are among them. As Michael McMahon of Warwick University points out, however, students themselves need to appreciate that in order to benefit in the fullest sense from university, they need to read widely, engage in discussion and above all stop expecting to be spoonfed. As for wider reforms of academic incentive structures, they are under discussion by a post-conference working group that plans to issue a report next year making recommendations for reform.

Economists are in the best position to understand the intellectual power and rigour of our subject, and its ability to contribute to tackling the enormous range of challenges in problems in today’s world, not least the continuing financial and economic crisis. Any intellectually honest economist will acknowledge that the length and severity of the crisis demand at least a certain amount of professional introspection and self-evaluation. Many will agree that economics does need to change. Surely the education of young economists is the best place to start?

Reference

Davies, Howard (2012), “Economics in Denial”, ProjectSyndicate.org, 22 August.

About the Author

Diane Doyle runs the consultancy Enlightenment Economics. She is a BBC Trustee and member of the Migration Advisory Committee and of the independent Higher Education Funding Review panel, and was for eight years a member of the Competition Commission (until September 2009). She is also visiting professor at the University of Manchester. She has a PhD from Harvard.

Diane specializes in the economics of new technologies, including extensive work on the impacts of mobile telephony in developing countries. Recent projects include work for NESTA on the wider conditions for innovation, and a study on the effects of mobiles in India. She is the author of several books, including The Soulful Science (Princeton University Press 2007), Sex, Drugs and Economics (2002, Texere), Paradoxes of Prosperity (2001, Texere), Governing the World Economy (2000, Polity) and The Weightless World (1997, Capstone/MIT Press), all translated into many languages. She has also published numerous book chapters, reports and articles, and was formerly a regular presenter on BBC Radio 4’s Analysis. Her next book is to be published by Princeton University Press in 2010.

Diane has acted as a member of the advisory board of ING Direct UK and of the stakeholder advisory panel of EDF Energy, and is a member of the advisory council of the think tank Demos. She was previously Economics Editor of The Independent, and earlier worked at the UK Treasury and in the private sector as an economist. Diane was awarded the OBE in January 2009.

 

 

PRIVATE EQUITY: A Contributing Factor to the Crisis or a Way to Resolve It?

Dr. Tamir Agmon is the  Associate Dean for Research and Development at the School of Management and Economics, Academic College Tel Aviv Yaffo in Israel. He is also  a Professor of Financial Economics at the School of Business, Economics  and Law at Gothenburg University in Sweden.

The economic ocean is comprised of a large number of small drops of water: a micro approach to the crisis

   The efforts of the Treasury and the Federal Reserve Board to deal with the current financial and economic crisis are focused on the “large picture”. Hundreds of billions of dollars are given to major financial institutions and to major manufacturers. This is clearly necessary and important. Yet, thousands of firms find themselves in financial and economic distress as a result of the crisis and as a result of their business policy in the boom period preceding the crisis. Firms that based their business policy on the assumption that American and other consumers will continue to buy more every year and financed this policy by borrowing ever increasing sums of money find themselves today in financial distress. Many of these firms have good business foundations.  They have the capabilities to design, produce and sell good products and useful services. They do have problems today in selling a particular product or a service to a particular industry, and they do have problems servicing the accumulated debt from the boom period. If they fail and disappear the cost to their employees, their suppliers, and to society as a whole is high. These small and medium size firms, often unknown to the public and below the radar of the media contribute substantially to the general welfare. It is impossible to address the needs and the potential of these firms at the macro, federal level. Fortunately, there is a private sector solution motivated by interests of investors, managers, employees and other stakeholders of the corporation. The solution is turnaround private equity investment by specialized companies and funds. Turnaround private equity is motivated by profit like any other investment activities. It is based on reframing the activities (assets) of a distressed firm, rearranging the liabilities to fit the new direction of the firm and manage the process of the turnaround. If successful, the private equity investors make an exit and leave the firm to continue and grow with other owners.

Continue reading PRIVATE EQUITY: A Contributing Factor to the Crisis or a Way to Resolve It?

Greek Crisis, Debt and Competitiveness: A Case Study of Irrational Expectations

Dr. Periklis Gogas is an invited contributor to The Business Thinker magazine. He is Assistant Professor at Democritus University of Thrace, Greece, teaching Macroeconomics, Banking and Finance. Recently, Dr. Gogas was a Visiting Scholar at the Ross School of Business, Uinversity of Michigan.

The economic crisis that troubles Greece since 2009 is the worst since WWII. A cascade of measures were taken by the Greek government and the troika supposedly trying to steer the Greek economy into primary surpluses and ultimately growth in order for Greek debt to become sustainable. The recipe chosen for this turnaround was apparently simplistic, one dimensional and is proving to be wrong severely damaging the Greek economy, its bond holders, the EU and casting serious doubts for the euro’s survival. The main ingredients of this failed recipe consist so far of huge direct and indirect tax increases, severe pay-cuts to public sector employees, a virtual halt in all government spending in education, health and government investment in infrastructure, research and technology. It is obvious to anyone, whether economist or not, that this policy is doomed for failure. Greece’s official statistics came to prove this belief. Two and a half years after the crisis unraveled, all the measures failed and this was no surprise to anyone but to the people that conceived them. Every single target projected by the troika’s “wise” and the Greek officials for government revenues when introducing a new tax or contractionary policy, was met with flat out failure. In economics we say that people have rational expectations when they do not make consistent errors in their forecasts about future events. They may be wrong many times but on average they must be correct. In this case, every single expectation is always over-optimistic and tax revenue falls short of the set targets. Anyone can see this, but the people who make the decisions. And even worst, instead of taking this as evidence that their policies are wrong and implausible they come back with new arrows from the same arsenal.

The examples of incompetence are numerous: one of the first measures taken was a major fuel tax increase that resulted in gas prices doubling from €0.85 to €1.70 per liter. At the same time, the annual road tax and car excise taxes increased in a similar manner. Apparently, naïve government officials assumed that government revenue will also double or at least increase significantly. Wrong! Government revenue from automobiles saw a sharp decrease from €1.7 billion per year to €0.7. Someone forgot to estimate the elasticity of demand on such huge price increases. To make the story even worst, after the huge decline in government revenue no one yet bothered to correct the mistake and increase revenues! This simple fuel and road tax hike of course had a multiple effect on the economy by burdening Greek production and worsening its competitiveness across-the-board.

Another example is tourism: supposedly tourism can be promoted as the heavy industry of Greece. At the same time, Greek government actions through indirect taxation actually divert tourism income from Greece to other countries. My master’s class students just organized a trip to Frankfurt. The whole trip including a direct flight to Frankfurt and a three-night stay in a down-town hotel costs €150 per student. A round trip from Thessaloniki to Athens by car would cost €150 for gas and €50 more for tolls. Apparently the Greek state is subsidizing the German tourism industry by making it prohibitively expensive for Greeks or others to travel within the country. Why would anyone implement such measures and even more so why stick to them when they are proven wrong?

Now, the bog issue is that the troika demands that private sector wages must decrease so that Greece will become more competitive. This is strange. Not even Greek employers themselves think this is necessary. A recent discussion with the president of a Greek chamber of exporters revealed something very important: total labor cost reflects not more than 8% of the final product price! Thus, even an extreme 50% decrease in private sector wages would not increase Greek competitiveness by more than 4%. Moreover, eliminating the 13th and 14th wage would further reduce government revenue through income taxes and social security contributions that are associated with these payments. The impact of these proposed cuts of course would be a vicious cycle that will further reduce total demand, production, employment and government revenue.  There is no economic reasoning for these contractionary and recession inducing policies. The evidence from their implementation is decisive beyond any doubt; they lead to a dead-end.

What is the solution then? Usually complex problems have simple solutions. The private sector is very efficient finding solutions to these problems when no governments or international institutions intervene and interfere. A firm that bears an unsustainable debt and is on the brink of bankruptcy would come into an agreement with its creditors to write-off part of the debt. This is a mutually beneficial solution. The firm will not go insolvent and the creditors will face the minimum possible capital losses. In the Greek crisis there is now the danger that both Greece will go bankrupt and bond holders will lose all of their investment. A real haircut of 50%-60% of nominal debt could render it sustainable. This haircut necessarily should include bonds held by both private investors and the European Central Bank (it is exempt now) and other creditors with only exception the bonds help by pension funds (they are not excluded now). The Greek banking sector could survive this hit by substituting Greek government bonds with an appropriate amount of government involvement in their capital structure financed by the troika. At the same time, a reduction of all taxes, direct and indirect, would help to stimulate the private economy, increase demand and jump-start production, employment and growth, ensuring that Greece could service the remaining debt and become credible again in international capital markets. And finally, Germany musts decide what it wants: a truly united Europe, or just some close trading partners for German products? If the former is the case, then they must immediately make the next necessary step for economic integration. This step will set the ground for the euro to survive and EU to become a true and stable union that can leave behind the fiscal problems that seriously challenge its structure and ultimate existence. This step is no other than the Eurobond: a united Europe that collectively borrows and distributes funds according to the need and economic cycle fluctuations. This, will speed up the convergence process within the national economies and significantly reduce from one hand the cost of borrowing to the economies in need and also one the other the risk assumed by international investors.

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About the Author:
Dr. Periklis Gogas is a faculty member at Democritus University of  Thrace and an adjunct lecturer at the Greek Open University teaching  Macroeconomics, Banking and Finance. He is also a Financial Consultant for Gerson Lehrman Group, Austin, Texas. He received his Ph.D.degree from the University of Calgary with supervisor Dr. Apostolos Serletis and worked for several years as the Financial Director of a multinational enterprise. His research interests include Macroeconomics, Financial Economics, International Economics and Complexity and  Non-linear Dynamics.