Issue Number 21, Spring Term 2009/10

Assumptions
The University of Warwick Economics Society Magazine

Proud Supporters of Assumptions

Dear Readers, Welcome to the second Assumptions Magazine for the 09/10 academic year. We aim to provide a mix of contemporary and theoretical articles across the economics spectrum. This edition focuses on Warwick Economics Summit 2010, including an interview with The Economists Cartoonist Kevin Kal Kallaugher. Other subjects explored include neoclassical economics, the issue of UK Debt and the Greek crisis, as well as a literature review. Finally, our guest contributor is Warwicks Professor Andrew Oswald. We hope you enjoy reading this issue and find it both thought provoking and engaging. Our aim is to create a platform for debate within the wider subject, and perhaps inspire you to write for the magazine in the future. The next edition will be published in the Autumn Term. Yours faithfully, The Editorial Team.

Cover picture: courtesy of Kal, The Economist, www.Kaltoons.com

Assumptions

University of Warwicks Economics Magazine

Chief Editor Co-Editors

Chris Walker Philip Rowan Tommaso Tomba Joseph OLeary

Contributors

Vanessa Albert Shalin Bhamra Rob Harris Nicholas McSpedden-Brown Prof. Andrew Oswald

Designer

Contents

The Greek crisis: time for the Eurozone to descend from Olympus? Is Britains public deficit such a problem? Warwick Economics Summit 2010 Assumptions interview: Kevin Kal Kallaugher Neoclassical economics, the financial crisis and heterodox economics The human tendency to see patterns in random data The end of laissez-faire: was Keynes right?

Assumptions

University of Warwicks Economics Magazine

The Greek crisis: time for the Eurozone to descend from Olympus?
From the outset of the current financial crisis a lot of speculation has risen regarding the robustness of the Eurozone. Many economists see the crisis as an interesting test for the Economic and Monetary Union of the EU that could provide answers to the endless debate between the sceptics and fierce defenders of the euro. However, comparison between the euro-members and their counterparts who have not adopted the common currency has remained difficult. The main element for comparison is probably the UK which was one of the first to be affected by the banking crisis with the run on Northern Rock. On the other hand, Sweden has suffered less from the crisis than most of the euro-members, a relative advantage that can be explained more by its societal model than its non-membership of the Eurozone. In fact the Eurozone resisted for a longer time before falling into recession, but the vulnerability of the different countries with regard to their membership of the currency union remains difficult to estimate in view of the global economic storm. The present economic downturn marks the first real test for the Eurozone, taking a turning point with the current Greek crisis. Everything started in October 2009 when Georgios Papandreous new socialist government opened Pandoras Box by announcing a budget deficit of 12.7% of GDP instead of the 3.7% claimed by the previous political leaders. This exceeds more than four times the 3% maximum level acceptable under the Stability and Growth Pact and is accompanied by a public debt representing 113% of GDP at the end of 2009, which could reach 120% in 2010. In reaction, credit rating agencies, beginning with Fitch, reduced Greeces rating which increased its risk premium of borrowing. This signal of a loss of credibility launched a new wind of panic in the markets and unleashed vast amounts of speculation. During the last two months, Contrary to what some the European authorities and Trichets ECB have been caught between a rock and a hard place, facing a predicament of the credibility of the Euro versus European solidarity. They cannot bail seem to fear, the Eurozone out Greece and they cannot print more money since its charter does not allow the direct buying is definitely not yet under a of governments bonds. The idea of Greece leaving the Eurozone which was briefly evoked has sword of Damocles. been eliminated, as well as resorting to the IMF which would undermine the role of the European Central Bank. Moreover, it seems that the decision ultimately lies with France and Germany, more so than the European Commission or the ECB. Despite the consensus on the impossibility of Greece going bankrupt, the crisis poses a real challenge for the Eurozone. Does it threaten the break-up of the monetary union? Contrary to what some seem to fear, the Eurozone is definitely not yet under a sword of Damocles. In fact, the troubles of Greece have raised several important issues that could have a positive impact on future reforms if they are taken into account, both from a political point of view and regarding the financial titans. First of all, the recent Greek odyssey has once again underlined the need for more controls and regulation of the financial institutions, and notably banks, that have gained disconcerting power since the 1970s. Indeed, the credibility of the country and its financial leaders was all the more shaken when the New York Times revealed that Goldman Sachs played an important role in the crisis by helping the country to cover up its debt. From 2001, that is the year Greece joined the Eurozone, the American bank, with JP Morgan Chases support, used a currency swap to allow the country to borrow without including the amounts in its official statistics. Legal? Yes, except that the exchange rate used would have been excessively favourable. The result was an additional 1 billion dollars added to the debt and 300 million dollars pocketed

Assumptions

University of Warwicks Economics Magazine

The involvement of states in the very same questionable strategies as companies such as AIG highlights that better regulation of the financial sector remains a Herculean task to achieve.

by the bank. The European Commission has thus expressed its will to fight against the distortion of data by taking proceedings against Athens. However, this was until the press disclosed a few days later that not only did Italy and Portugal use the same strategy, but also Germany and the United Kingdom. The involvement of states in the very same questionable strategies as companies such as AIG highlights that better regulation of the financial sector remains a Herculean task to achieve.

In light of these events and with all the disillusions of the global financial crisis, it appears difficult not to remain on the path of co-operation launched by the G20 in 2009. Even though the question of Community solidarity is not set in the text, it is a burning issue which has been increased by the risks of contagion of the Greek crisis. As the Competition Commissioner, Joaquin Almunia puts it, the difficult situation in Greece is a matter of common concern for the Euro area. There is serious risk of spillover to other parts of the euro area. Indeed, the Greek crisis is also a crisis of the Eurozone and investors point the finger at Portugal, Ireland and Spain, whose debts have been worrying too creating the nice acronym PIGS. According to the Markit CDS index, government bonds have reached a record high in these countries as a result of the contagion from Greece. Furthermore, French and German banks together hold $115 billion exposure in Greece and much more in the other PIGS. The interdependence of the financial system goes even further as European banks have lent more than $252 billion to the Greek economy, according to the Bank for International Settlements. After several weeks of indecision at the European level, the German Chancellor Angela Merkel stated that, what happens in one member state affects all others, especially as we have a common currency, which means we have a common responsibility.
Courtesy of Kal, The Economist, www.Kaltoons.com

The Greek crisis confirms another wider problem that the European Union faces: the heterogeneity of the member countries of the Eurozone. The economic performance of countries such as Greece has not yet caught up with the founding member countries of the Union, despite meeting the economic and political conditions of admission. The strengthening of the EU should probably rely on a reinforcement of its current framework to resolve the significant disparities between the different countries instead of considering an enlargement of the Union. The UK, which has been more concerned with the integration of the Eurozone given the depreciation of Sterling, is again likely to fall in line with public opinion, which remains largely hostile to integration with the Eurozone. In conclusion, the Greek crisis reminds us of the longstanding Achilles heel of the Eurozone: the inexistence of a common economic policy. The convergence of economic and monetary policies that was supposed to be a consequence of the Union has never really happened, impeding the performance of the Eurozone. Despite the reluctance of many countries, most notably Germany, the current events could be a trigger towards achieving better and much needed political governance of the Monetary Union. Notably, the crisis has confirmed that the supposed advantage of a coordinated monetary expansion can have a strong impact only if it is associated with fiscal policy, which implies deeper European cooperation. The stakes are therefore economic as well as political, and even though the task remains difficult, one can hope that the Greek crisis will convince European leaders once and for all to follow this Ariadne's thread. Vanessa Albert

The UK, which has been more concerned with the integration of the Eurozone given the depreciation of Sterling, is again likely to fall in line with public opinion, which remains largely hostile to integration with the Eurozone.

Assumptions

University of Warwicks Economics Magazine

Is Britains public deficit such a problem?

What is the furore about Britains public deficit? A ferocious debate has begun not only among politicians, but now prominent economists and academics. In the run-up to a General Election, it is important to discuss the three main political parties contributions to the debate and analyse the current academic position. Britains position, specifically in relation to the G7 countries and other European nations, can be examined. The UK entered the recession in pretty good fiscal shape; with net debt well below 40% of GDP, the second-lowest in the G7 except Canada. And inevitably, all countries debt is projected to rise over the subsequent two years. What is alarming is the rate of growth of British net debt; predicted to double over 5 years, while even the most debt-ridden countries forecasted debt growth, Italy and Japan, is only 20% and 50%, respectively. But why is UK public sector borrowing forecast to increase at such a rate? A forecast based almost entirely on the composition of the governments revenue intake combined with the discretionary stimulus provided to the economy.
140.00 120.00 100.00 80.00 60.00 40.00 20.00 0.00 France Germany Canada Italy Japan United Kingdom United States 2007 2008 2009 2010 2011

In the Pre-Budget Report, National Insurance and Income Tax, which both provide over 50% of government revenue, are forecast to fall by 8.5% while Corporation tax constituting 10% of intake is predicted to fall by almost 25%. Furthermore, VAT receipts, which make up 18% of total revenue, are down 14% as a result of the temporary tax-cut. In addition, governmental Financial Sector Intervention (bank bailouts) which constitutes to 12% of the National Debt, accentuates the size of the debt.

As far as the adverse effects of the debt on the economy go, a brief look at the yield curve for the US bond and UK gilt rates Figure 1: G7 Net Debt as % of GDP, Source: IMF World Economic Outlook shows little to differentiate between the two. The US starts lower due to an initially lower discount rate (0 0.25%), but the increases remain steady in relation to each other. In fact, as the UK generally has long maturities on its much of its debt, the UK rate falls below the US for longer term debt. Clearly the markets believe that the current state of the finances need not be punished with a higher risk premium. The much lauded concern that the UK could lose its Triple-A debt rating seems overstated, given the markets outlook. Indeed, the credibility of the credit rating agencies themselves could be questioned, given their role in the current crisis. It is safe to assume that the next General Election will be fought primarily on the way to deal with the current fiscal problems. The Tories had previously been speaking loudly about their desire to cut the deficit as soon as possible if they got into office, while Labour have stuck to their strategy of halving the deficit by 2014 throughout the past year. The Liberal Democrats remain characteristically vague about their claims to be committed to setting out the tough choices. Following the publication of the first of three letters to The Times and the FT, the Conservatives have claimed that their policy of fiscal retrenchment is a consensus of economic opinion. Ex-MPC member David Blanchflower is quick to point out that the letter, while quick to claim there is a compelling case that the first measures [will begin] to take effect in the 2010-11 fiscal year, offers very little substance in terms of implementation. The letter has been quickly rebutted by two letters to the FT, whose signatories include University of Warwick Professors Lord Skidelsky, Marcus Miller and Peter Hammond, along with Brad DeLong and Joseph Stiglitz among others. They argue that urging a faster pace of deficit reduction to reassure the financial markets implicitly accept[s] as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place! The third letter, signed by Lord Layard, Alan Blinder, Robert Solow and Rachel Lomax among others, outlines that private households and businesses have had to increase their savings, which are used to purchase government debt and if the government did not take up the slack, there would be a deeper recession. The central element of the argument is the timing of fiscal retrenchment. Lord Layard et al believe it is unlikely that in the short term government debt will pose a significant problem and claim that what is needed then is much more detail for the following years, and a radical plan for the medium term. Moreover, Paul Krugman points out that fiscal contraction of an additional one or two percent of GDP in the near future has essentially no significance for the sustainability of government finances Confronted with almost identical manifestos, we face a particularly tough choice this May. Rob Harris

Assumptions

University of Warwicks Economics Magazine

NNOVATIVE?
Nationwide Opportunities Spring and Autumn 2010
A lateral as well as a logical thinker? Then youll feel at home among the imaginative people who mark us out among professional services firms. The ideas we generate boost the performance of every type of business on every kind of level. And we have plenty of ways to boost your performance too. In fact, youll benefit from training and prospects that have made us the only firm to come first in The Times Top 100 Graduate Employers survey for six years running. If you aspire to bigger and better things, aim for the best.

Assurance Consulting Tax Financial Advisory Actuarial PwC Legal Requirements: 2:1 in any degree discipline. From 300 UCAS tariff or equivalent.

pwc.com/uk/careers
Text: PwC to 85792 to visit our website on your mobile
(Texts charged at your standard network rate.)

We value diversity in our people.

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

Warwick Economics Summit 2010

Warwick Economics Summit 2010 took place from the 19th to the 21st of February. This years summit promised much from the outset, with tickets selling out in record time and a strong line-up of inspiring, thought-provoking and challenging speakers. External students travelled from all over the world to take part, as 39 universities from 16 countries across 4 continents were represented, and it certainly didnt fail to deliver. Whilst many speakers understandably chose to focus their attention on the ongoing financial crisis, there were a wide range of subjects covered. Friday saw Bob Janjuah, Chief Markets Strategist at RBS, begin the proceedings with a sobering talk on the problem of the current scale of worldwide debt. This was followed by a characteristically animated speech from Lord Digby Jones, UK Ambassador for Trade and Investment. His main themes included the importance of skilling the people and that the UK has nothing to fear from the developing world if it can do so. Lord Jones was also keen to dispel the myth that the UK doesnt produce anything anymore, citing the aerospace, pharmaceutical and food industries. He also pulled no punches on the European Union, insisting on a highest common numerator approach and that those (countries) with broken legs should be mended, not breaking others legs The evening ended on a lighter note, courtesy of a very entertaining presentation from The Economists longstanding cartoonist Kevin Kal Kallaugher, who made a much welcome return to the Summit (see Assumptions interview on page 9). Kal gave a humorous look back over the last year for political satire and a look ahead through his famous caricatures and drawings, and even gave a live lesson on how to draw Barack Obama. Saturday began with a challenging talk from the Head of Warwicks Economics Department, Abhinay Muthoo, on democracy and economic performance. The audience was encouraged to think about China and Indias common breakneck growth and the differing political settings in which they take place. How does democracy affect economic growth? Might Indias economic performance be even higher were it to follow China and become a non-democracy? These were just some of the thoughtprovoking questions raised. Professor Muthoo concluded that economic performance needs first and foremost to work well, for which property rights enforcement, the establishment of the rule of law and contract enforcement are critical in their influence on expectations. Pete Lunn of the Economic and Social Research Institute provided a fascinating insight into the revolutionary field of behavioural economics and the impact its findings are having on traditional economic theory. Behavioural economics is the empirical study of economic behaviour, which tries to understand our economic instincts and why we do certain things. Dr. Lunn highlighted some of the groundbreaking research that has been carried out, including studies which show that the assumptions of orthodox microeconomic theory which state that individuals are purely self-interested, rational and independent have been disproven. It appears that we also care about fairness and the counterpartys transaction surplus. This is why we wont pay very high prices for concert tickets, despite the fact that this may be the market clearing price. It was also proposed that our preferences are reference dependent and that we value something more when we have it, the so-called endowment effect. Dr. Lunn concluded that the primary scientific task facing economists at present is to devise a more behaviourally realistic form of microeconomics.

Assumptions

University of Warwicks Economics Magazine

Saturday also saw the special guest appearance of none other than the Chancellor of the Exchequer, Alistair Darling. This wasnt part of the program but made for a welcome surprise as participants got to hear firsthand what is in store for the UK economy in the future and to pose some challenging questions themselves. The afternoon sessions began with a talk from Dr. Paul Wilmott on risk management and an alternative insight into the origins of the current financial crisis through an analysis of the derivatives market. Liam Halligan, economist and journalist, then tackled the question of the sub-prime debacle - what will future historians say? This was highly critical of the Western Worlds response and that the cure is killing the patient. He also expressed concern about the potential inflationary pressures to come, the issue of still high global leverage and the benefits of reintroducing the Glass-Steagall Act, separating investment from retail banking. Mr. Halligans other conclusion was that the financial crisis will result in a shift of global markets eastwards with the expectation of greater rewards and lower risks. Participants then had the opportunity to put their burning questions to a Question Time panel which produced some lively discussion, before attending the inaugural Dinner and Dance event, complete with Economics quiz. Sundays proceedings took a slightly different format in the form of several micro talks on a diverse range of topics. Dan Ariely of MIT and Duke brought further thoughts on behavioural economics, while Nikolaus Wolf of Warwick elaborated on how economics should not ignore the past and how economic history can help us use, test and bin models. Liam Delaney brought valuable insight into some of the European policy changes concerning behavioural economics. Nic Marks of the New Economics Foundation then gave a fascinating talk on happiness economics and its use as an alternative measure of wellbeing compared to GDP. In particular he cited the case of Bhutan which has adopted the Gross National Happiness index and measures proposed by French President Nicolas Sarkozy to come up with an alternative measure of wellbeing. Amongst some fascinating facts he revealed that Costa Rica is the happiest nation in the world and the five secrets to wellbeing. Karen Chouhan of Equanomics spoke on the problem of the inequalities between the general and ethnic minority populations which stimulated a lively question and answer session. Delegates were then given the opportunity to reflect on what they had heard over the course of the weekend with a video montage of what economics means to me from some of the leading thinkers from around the country. This years Warwick Economics Summit was undoubtedly an enormous success which is testament to the hard work and organisational skills of the Summit Team. Next years summit is certain to be just as big, so if you would like to be involved look out for further details to come. Philip Rowan

Assumptions

University of Warwicks Economics Magazine

Assumptions interview: Kevin Kal Kallaugher

Editors Tell us about your career and how you came to be at The Economist Kal Every cartoonist has got a different story, because there are no classes on how to become a cartoonist, and my story is particularly curious. I came to the UK right after through some sort of filter of graduating from university, to do a bicycle tour leading a group of American tourists around your own, through the prism the UK. After this I got a job playing semi-pro basketball down in Brighton, but the team of your own experience, and had some financial difficulties in the first season. I had done some cartoons at university, partisanship comes if people for the school paper, and my senior thesis was a 13 minute long animated cartoon. So when the basketball team started having trouble financially, I went to the streets and started doing are seeing it through a very caricatures. Eventually I started applying to the papers and got myself a trial at The narrow filter. Economist. Now I knew absolutely nothing about British politics, so my friends from the basketball team told me to just sit down the night before and watch Newsnight. On Newsnight, there was a feature about Dennis Healy. Now this is a guy who is perfect for cartoonists: a round tomato of a face with big bushy eyebrows and little buck teeth like a rabbit, so I sat down and sketched away. The next morning at The Economist I sat down and they said, Okay can you draw Dennis Healy for me? So I threw it together and that was 32 years ago. Eds With reference to The Economist, how would you say you keep political satire, non-partisan?

In some ways, satire is

Kal In some ways, satire is through some sort of filter of your own, through the prism of your own experience, and partisanship comes if people are seeing it through a very narrow filter. I like to keep my filter broad, where I can see the mistakes and problems that each party from each country has. It doesnt mean that I treat every party the same, but Im not going to be prejudiced before I come to the facts, the essence of journalism. Having said that I regard myself as a columnist, whos a commentator and is in the business of trying to critique things that are going wrong. So the line I like to give is Im 100% in favour of everything thats right, but I dont think that any one party in power has a monopoly on all things right. Even as a voter and participating in a democracy you can see people making mistakes and who are worthy of criticism. Politics by its nature involves all sorts of compromises, particularly when you are campaigning on all sorts of ideals but when it comes down to it you need to do all the stupid stuff. We in the press, our business is to keep everyone straight and ensure they are serving the voters as best as possible. Essentially I try to be fair and sound in my judgements but Im still looking at things from my own personal point of view to some degree. Eds Would you say you are given quite a free reign in terms of your cartoons?

Kal To some degree they give me a free reign but in other ways Im working within certain structures. You work in a society where you dont want to be looked on as racist, sexist or within the realm of culturally offensive material. Then you work within what they consider the parameters of their political point of view. The Economist is very tolerant but of course has a specific agenda. Nothing is signed, they speak as a singular voice, a voice which is quite libertarian, but then they dont want somebody veering way off course because it works outside of their world. Within my opinions I work within their framework. There has been an odd occasion where I have come up with a cartoon which is diametrically opposed to their lead editorial, so they say do you mind holding it for this week and run it again next week. I have a great deal of freedom, but with all freedom comes responsibility, and that is to do something which is journalistically sound and has some integrity. Eds Given that the magazine is published in a large number of countries, do you think cultural differences are a big problem? Kal They are, you have to speak in a coded language and many metaphors are culturally specific, for example using a baseball metaphor in

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

Assumptions

University of Warwicks Economics Magazine

America. One of the interesting things is on our website we can now get comments on the cartoons, and I get scores of comments on cartoons which broach 3 major subjects: Iran, China and Russia. Some of them are official comments, people whose job it is to criticise, but a lot of the time its people not understanding the joke and the context. Some people like to wilfully misinterpret things, but thats another story entirely. But there is another side to the story, take the Danish cartoonists. Here is a situation where if you misread your audience, or if they were only targeting Denmark but it is read elsewhere, it has massive implications. It is one of the minefields in front of us. That story isnt over yet, there have been cartoonists outside Denmark who have been arrested and beaten up because they have done things. There was a comic strip guy in Burma who drew a comic with a cat called Muhammad. Some people took this to be offensive, there were riots and he was arrested and put in jail. This story is going to play and play. Eds Youve been at The Economist for 32 years now; do you think its stance has changed a lot following the crisis? Or indeed your stance? Kal I guess as a professional cartoonist Ive had my fair share of minor spats with different groups that have objected to work that you do because satire is a negative art in which youre making fun of people; youre always ticking people off. But its the question of when you tick people off so much that you become ineffective because like I said were columnists, Im trying to get a point across, Im trying to spur a discussion. But if people are so hot-headed and angry that the discussions not heard over the yelling then you havent done your job. The Economist has maintained a fairly consistent line about freedom of expression and tolerance for decades, so in that way I think theyve been remarkably consistent. What I think is amazing is their consistent support of me as a satirical voice in their publication and understanding that this is a valuable thing to do in journalism. Eds Do you watch a lot of cartoons or animated films? Which one would you say is the best?

Kal Yes I do, I watch them all as much as I can. I love the Simpsons and South Park. From a 3D animation and technical point of view Pixar are fantastic. But the man hours that are involved with that are huge and so the films are dripping with beauty and you get so engrossed. Avatar is full-on animation with the guys in motion capture suits and completely digital sets. I can imagine in a decade from now motion capture will be fairly inexpensive and the political cartoons that we see in newspapers will instead be done by guys who will have built a dozen main political characters and will produce a 30 second full 3D animation in motion capture of the days news. They recreate what happened in 10 Downing Street - the real conversation behind the news today. Eds What would you say are your main sources of inspiration?

Kal Well part of it is just listening to the news. Even in my studio in Baltimore Ill listen to Radio 4 and the news quiz in the UK. I love the Daily Show and to hear great satirists at play. Its a constant search to try and keep abreast of whats going on in the news so Ive got lots of websites I go to, newspapers, magazines and blogs. You try to get a global feel for different points of view and piece together as much information as you can. Watching TV, listening to the radio, its non-stop ingestion my brains complete mush by the end of the week. But I think trying to keep up with everything is what gives you the inspiration. Eds What do you think The Economist will do whenever youre gone?

I have a great deal of freedom, but with all freedom comes responsibility, and that is to do something which is journalistically sound and has some integrity.

Kal I dont want anybody to take over! Well Ive been with them for 32 years and my role is constantly growing and changing, as well as the publication. Everyones trying to figure out how journalism will be digested in the future with things like the iPad and e-readers. I have this notion and dream that youll see much more animation, but hopefully youll still have the old-fashioned. As long as theres a magazine and printed page theres hopefully going to be a great cartoon in there. I think the dream is that the next generation of satirists are going to be animators because its all about what excites you. When I was growing up it was stuff on the printed page that was magical and current generations dont get excited by the drawn stuff so much. Philip Rowan and Chris Walker

Assumptions

University of Warwicks Economics Magazine

10

Will China Lead the Global Neoclassical economics, the financial crisis and heterodox economics Economy to Recovery?
A recent online poll organised by the Real-World Economics Review (RWER) Blog, who edit the online economics journal of the same name, has come to a close. The poll asked voters to nominate economists for the Dynamite Prize of Economics, to be awarded to the three who contributed most to enabling the Global Financial Collapse (GFC). The economists short-listed as the final ten were: Fisher Black and Myron Scholes, Eugene Fama, Milton Friedman, Alan Greenspan, Assar Lindbeck, Robert Lucas, Richard Portes, Edward Prescott and Finn Kydland, Paul Samuelson and Larry Summers. In the end, the winner was Alan Greenspan, followed by Milton Friedman and Larry Summers. The editor of RWER, Edward Fullbrook, said that the prize had been established in response to attempts by economists to evade responsibility for the crisis by calling it an unpredictable, Black Swan event. While the unpredictability of the GFC is open to question, it is interesting to see that he considers all of the aforementioned economists fall into the general denomination of neoclassical economists. Indeed Fullbrook stresses that it is the delusional mindset of neoclassical economists that caused the GFC. There are realist approaches to economics but which through power politics have been suppressed in universities and excluded from government policy making. As a consequence, a poll has now begun in order to determine which non-neoclassical economist fully deserves the Revere Award in Economics (in honour of Paul Revere, an American activist during the American Revolution). It will be awarded to the 3 economists who saw the GFC coming, and whose work is most likely to prevent another GFC in the future, says Fullbrook. However, the task of clarifying what exactly makes neoclassical economics so pervasive is not an easy one. E. Roy Weintraub, Professor at Duke University, notes that the American economist Thorstein Veblen was the first to use the term in a pejorative sense, to distinguish marginalists in the tradition of Alfred Marshall, from those in the Austrian School. However it is now known more or less as a synonym for mainstream economics. He stresses that neoclassical economics is indeed more of a meta-theory, of which the fundamental assumptions are 1. People have rational preferences among outcomes, 2. Individuals maximize utility and firms maximize profits. 3. People act independently on the basis of full and relevant information. It is also defined methodologically with a strong use of mathematical and analytical methods, namely it is the delusional mindset through constrained optimization problems, and emphasises the existence of explicit of neoclassical economists equilibria.

that caused the Yet this general framework doesnt do much to show the potential dangers of neoclassical financial crisis

global

economics. Christian Arnsperger, professor at the University of Louvain in Belgium, and Yanis Varoufakis, professor at the University of Athens in Greece, however, provide a Edward Fullbrook scathing account of how such a framework can be pushed to excess. In a paper written for the Post-Autistic Economics Review (predecessor to the RWER), they enunciate the three axioms responsible for [the] theoretical oeuvre, practical irrelevance and, thus, discursive power [of neoclassical economics]. They are right to stress first of all, however, that criticisms of neoclassical economics that refer to its positing hyper-rational bargain-hunters, never able to resist an act which brings them the tiniest increase in expected net returns and other neoclassical features such as market-clearing, selfish individualism, or Pareto optimality miss their target as these are not ubiquitous and necessary features of neoclassical theory. They then define three axioms, which, on the contrary, underpin all (and only) neoclassical theory: methodological individualism, methodological instrumentalism, and methodological equilibration. The first implies that socio-economic explanation must explicitly be sought at the level of the individual, rather than any wider social structure. The second means that all behaviour is to be understood as a means for maximising the satisfaction of preferences, however dynamic and endogenous they may be. The final axiom refers to the axiomatic imposition of equilibrium as a situation that must necessarily occur. The authors also claim that such meta-axioms are beginning to develop much closer links than before, and conclude that it is, therefore, uncontroversial to state that every aggregate phenomenon scrutinised by neoclassical minds is explained increasingly and exclusively as some axiomatically imposed equilibrium emerging from the interaction of instrumentally rational individuals who are either optimising consciously (as in rational choice or game theory) or are drawn to such behaviour through a process of natural selection (as in, for instance, evolutionary game theory). And they assert that the meta-axioms, as the foundations of neoclassical economics, have gained such discursive power and resistance to pluralism for two reasons: in questioning the meta-axioms one will never get published in a top journal, but more importantly, in keeping silent about them, neoclassical economics discursive power is mechanically increased. Such an explanation is certainly open to criticism. However to refute the existence of the three meta-axioms would undoubtedly require some intellectual acrobatics that could well border on bad faith. Perhaps the legitimacy of such vitriol against neoclassical theory should be measured by the yardstick of the plausibility of its alternatives. Some of the more popular nominations for the Revere Award in Economics so far are Dean Baker of the Centre for Economic and Policy Research, Steve Keen of the University of Western Sydney, Hyman Minsky, Ludwig von Mises, Irving Fisher and John Kenneth Galbraith. Nicholas McSpedden-Brown

11

Assumptions

University of Warwicks Economics Magazine

The human tendency to see patterns in random data

Empirical evidence is more important than theory. But when I was young I did not appreciate how easy it is to find exciting, but illusory, patterns in data. With a collaborator, Amanda, I am doing experiments and we have a theory that we call Time of the Day Effects, hypothesising that the time of day has important consequences. I am working on coin-tossing - heads and tails. She is working on the spin of a roulette wheel, with only two colours - red and black. I throw a coin each morning 6 times; then the same in the afternoon: 12 throws a day. I do this for a week, so the sample size is 84. In the other experiment, Amanda is spinning her roulette wheel. She also does it 6 times in the morning, and 6 in the afternoon, for 7 days. Our total observations are therefore 168. We agree to collaborate on any finding in either experiment, whatever turns up, and to send a jointly authored paper to the Journal of Scientific Discoveries.

76% of the time we will be able to write a paper proving, at the 0.001 level of statistical significance, some version of coins come down heads on March 27th.

How likely are Andrew and Amanda to be able to write a paper with a time-of-the-day effect that is statistically significant at the 2% level (p< 0.02)? The probability of flipping a coin 6 times in a row and getting a head each time is (0.5)^6 = 1/64. Hence the probability of this event is less than 2%. So what is the chance that, if I search across all my data, there will be at least one morning or afternoon with a run of a head or a tail? It is (1 P), where P = probability there will be neither a heads run nor a tails run). There are two types of run, one for heads and one for tails. So the probability of no heads or tails run for my experiment during the week is (31/32)^14 = 0.64. Therefore 36% of the time we will be able to write a paper finding some version of heads come up on Wednesday afternoons. But Amanda is also working in her lab and generating data. The probability that either Amanda or I find a result is (1 P), where P = probability there will be neither a heads or tails run nor a red or black run. The probability that there will be neither is (31/32)^28 = 0.41. Thus 59% of the time we will be able to write a paper proving, in a way that greatly exceeds the ninety-five confidence level, some version of heads come up on Wednesday afternoons or reds occur on Saturday mornings. However, this pattern is an illusion caused by excessive searching. Suppose we extend our theory to day of the year effects and that our referees tell us we need to enforce a 0.001 statistical-significance level. We now throw the coin ten times every day for a whole year, and also spin the wheel ten times. The chance of a head coming down ten times in a row is 1/1024. Because there are 365 days in a year, the chance that neither Amanda nor I get any run of 10 in a single day is thus (1 ((511/512)^730)) = 0.24. Hence, 76% of the time we will be able to write a paper proving, at the 0.001 level of statistical significance, some version of coins come down heads on March 27th. However, we have again subconsciously searched too much. When looking at data, human beings readily discard theories and patterns that do not work, whilst subconsciously dreaming up new ones. They latch on to exciting results that they had not neither forecasted nor expected. If quizzed by sceptics, researchers tend to reply: But my result is statistically significant at the 1% level. This is a pervasive problem; we are all prone to the error, and it is a mistake to be haughty about it. But independent replication is the only convincing check on a finding. Myself included, we all need humility when undertaking empirical research. This is especially true when using small data sets of less than 1000 observations. Therefore I try to ask myself: (i) can I check my exciting discovery by making sure that it is there within subsamples of my own data, by splitting the sample into men and women, or young and old, or before 1980 and after 1980? (ii) did I come up with my theory ex post, after already seeing the data? (iii) have I, without realising it, searched across lots of possible empirical patterns before stumbling on my exciting finding? Unfortunately, if we subconsciously pre-search for patterns then we cannot apply conventional statistical significance levels when we hit upon an exciting discovery in the data.

When looking at data, human beings readily discard theories and patterns that do not work, whilst subconsciously dreaming up new ones.

The human mind tends to see convincing patterns where there are none. To try to guard against this, I find (i), (ii), and (iii) helpful, and would cautiously recommend them. Of course, being human makes us all prone to this phenomenon. Prof. Andrew Oswald

Assumptions

University of Warwicks Economics Magazine

12

The end of laissez-faire: was Keynes right?

In his short but powerful piece entitled The End of Laissez-Faire, Keynes walks us through the rise of laissez-faire as a political doctrine and the importance of governments in limiting large corporations. However, was Keynes view correct? Can it really be applied to the real world? The glut of front-page stories on multi-million dollar bonuses and surprisingly high profits in the news at the moment suggest that the banking industry is actually recovering from the economic downturn. Well, in the USA at least. In fact, as I write this article a number of senior executives at top investment banks are foregoing their bonuses in a desperate attempt to get a solid pat on the back from Average Joe who will cry out: what a great bunch of blokes, I guess I can forgive you. Whilst it is safe to say the general consensus favours a punch in face, one cannot forget the important role for the world economy that these banks play, with large profits on their part unfortunately being good news. The financial services play a huge role for the UK economy, accounting for more than 10% of UK GDP (Financial Times), and the global economic downturn certainly opened many peoples eyes to the importance of institutions in society. The global economic downturn brought up much deeper concerns, such as an imminent collapse of capitalism, or an expected revolt by the masses against the fat cats of industry. Now, in light of signs of recovery, governments are keen to clamp down on the financial services and essentially reduce the large inequality gap between the average person and the super rich. Enter Keynes work The End of Laissez-Faire. Despite its basis from a lecture given in 1926, the text could not be more relevant to the world of today with an intense discussion on the rise of the political doctrine that is laissez-faire, the possible solutions as to when it needs limiting, and where it may reach its optimal position and begin to decrease in popularity as a dogmatic idea.

The sheer level of trust Keynes has in the invisible hand certainly shakes the credibility of his work, and although he does Keynes firstly sets out the roots of laissez-faire and the importance of the concept of question it, the extent to which individualism to its existence. Hume defines utility as that of just Calculation, and a he does is unsatisfactory.
steady preference of the greater Happiness with Keynes making it clear that the origin of laissez-faire is in political philosophy.

He raises ideas about the concerns of society and how they compete with those of the individual; citing Rousseau and his General Will, where equality is not only the starting-point but the goal. Keynes draws parallels with laissez-faire, raising the issue of the invisible hand in society, noting that the utility of the individual and its conflict with that of society is something the political philosopher no longer needs to be concerned with as [the business man] could attain the philosophers summum bonum by just pursuing his own private profit. Of course in todays world, one can question the idea of the invisible hand. The mass unemployment of only a number of months ago being still fresh in the publics mind and making the almost unreal bonuses more akin to a knife in the back of society. The sheer level of trust Keynes has in the invisible hand certainly shakes the credibility of his work, and although he does question it, the extent to which he does is unsatisfactory. Despite this, his initial analysis is clear in laying down the foundations and ultimately provides the reader with a credible account as to why laissez-faire is so dominant today.

Keynes almost immediately prescribes a cure to the problems of laissez-faire: the understanding that one of the finest problems in legislation is knowing when the state should interfere in public life.

In his second chapter, Keynes continues to explain how the concept of laissez-faire is no longer the child of philosophy but in fact has become a concept of concern for political economists. He states a key case in favour of laissez-faire is that protectionism has caused a decline in the exporting of manufactured goods. His case study of Marquis dArgenson as the first writer to use the phrase [laissez-nous faire] grants Keynes historical credibility and instantly gives any reader a sense that his piece has been well researched.

Keynes once again confronts the issue of inequality, citing Bastiat who wrote that laissez-faire leads to the equalisation of individuals in the general amelioration. Here Keynes views laissez-faire favourably, and with good reason: the doctrine aims to increase all living standards to the same level. It is these views that cause Keynes to make such claims as the dogma [has] got hold of the educational machine, in explaining the popularity of laissez-faire.

13

Assumptions

University of Warwicks Economics Magazine

Of course one can poke holes in this idea of equalisation, with the bonus-culture today doing all it can to prevent a closing of the inequality gap. In the long run, this gap cannot be expected to close with senior executives finding it increasingly difficult to turn down bonuses, with Eric Daniels of Lloyds Banking Group having to yield to growing pressures to waive his 2.33m bonus (hardly the signs of an individual eager to equalise societal well-being). It is only in chapter four where Keynes critiques laissez-faire. However when he does it is short, clear and direct. Firstly, he claims that there are no guaranteed rights under the doctrine. Secondly he attacks the idea of the invisible hand, explaining that it is not a correct deduction that enlightened self-interest always operates in the public interest. Although short in his analysis, Keynes almost immediately prescribes a cure to these problems: the understanding that one of the finest problems in legislation is knowing when the state should interfere in public life.

Keynes ultimately feels that capitalism cannot be judged objectively, but states that when proper managed it is more efficient in achieving economic ends than any other system.

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

Where Keynes falters, and rather significantly, is in his explanation of the tendency of big enterprise to socialise itself. He essentially feels that as large companies grow, the relationship between stock holder and manager begins to waver. Stock holders are content with reaping the benefits of a steady revenue flow. However, the management is concerned with avoiding criticism from the public. This leads to Keynes claiming that the battle of Socialism against unlimited private profit is being won in detail hour by hour. Surely it is absurd to assume that large organisations begin to care about public welfare as oppose to profit maximisation? It is the nature of human society to believe that more is better, and as a result profit maximisation will never be sacrificed for societal welfare with regards to a private firm. (Do we honestly expect Goldman Sachs to halt their current level of generation of $439 per second?) As a result, Keynes is wrong in stating that socialism will overtake laissez-faire, with the large profits being reported by large banks so soon after the global downturn reflecting their monolithic power. Overall, Keynes claims that the debate as to whether laissezfaire is declining is a psychological one, rather than a technical one. He states an argument outlining the conflict between religious views and the nature of man, with religious individuals tending to denounce material possessions, whilst men cannot do without the money-motive. Keynes ultimately feels that capitalism cannot be judged objectively, but states that when proper managed it is more efficient in achieving economic ends than any other system. I feel that in his text, Keynes makes a number of useful insights. His third chapter spends time analysing the relationship between Darwinism and laissez-faire, claiming both to be natural and efficient. It is certainly well written and makes a number of useful arguments regarding the rise of free markets, whilst noting the need for regulation and the fact that there is a role for the state. Despite these positive points however, Keynes does stumble in places. I feel that his argument could have been somewhat more balanced, that he is perhaps too weakly critical of laissez-faire, and that he places too much hope on the nature of man. The economic bounce-back has shown just how strong laissez-faire is as a doctrine and I feel that any expectations of its downfall will be held in vain. Shalin Bhamra

Assumptions

University of Warwicks Economics Magazine

14

NFORMED?
Nationwide Opportunities Spring and Autumn 2010
Like to find out the facts? Then discover how much we can offer people with the right mix of employability skills. Youll learn from the experts whove made us a world leading professional services firm. Youll help tackle critical business issues and the most complex commercial challenges. And youll soon see why were the only employer to come first in The Times Top 100 Graduate Employers survey for six years running. Get to know an organisation that can make you even more knowledgeable, whatever direction you want to take.

Assurance Consulting Tax Financial Advisory Actuarial PwC Legal Requirements: 2:1 in any degree discipline. From 300 UCAS tariff or equivalent.

pwc.com/uk/careers
Text: PwC to 85792 to visit our website on your mobile
(Texts charged at your standard network rate.)

We value diversity in our people.

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