Surviving the Recession

Nature in its 19 February 2009; 457 (7232): 935-1046 issue has come up with a special on the current recession. There are seven commentaries and two book reviews. There have been other related items that have been published over the weeks and all are available at Recession Watch. But, I will concentrate on the nine in the concerned issue.

John Geanakoplos in his End the obsession with interest emphasiss on regulating leverage (the collateral a borrower needs to provide). His reference to Shakespeare's Mercahant of Venice where the collateral agreed between Shylock and Antonio was on a pound of flesh (not interest) if the latter reneged. The role of the authorities here is to see to it that it is "a pound of flesh, but not a drop of blood."

In her Cooperation must rule Noreena Hertz states that the crisis has led to a new socio-political environment where cooperation rather than selfish behaviour would be the rule of the game. For longer-term viability, the corporate leader should be the one who exhorts 'Co-op capitalism' as against 'Gucci capitalism'. I would add, talking lessons from Gift societies also implies that one should cultivate norms and conventions to make cooperation a dominant solution in a prisoner's dilemma setting.

The mantra by John Browning is to Cut costs and sell what you can. For this they have to identify and cut 'dark matter' and be 'flexible' in their thinking and be on the look out to cash on their existing products/expertise. My take is that all this is possible if what you are doing adds value in a fundamental (not superficial) way.

Atsushi Sunami and Kiyoshi Kurokawa invoke that this is No time for nationalism. Drawing up from Japan's lost decade of the 1990s where the escalating real estate prices had adverse impacts on the stock market and banking sector. A positive outcome of this was the coming together of policy makers and scientist and enhancing of research funding in subsequent years. The current scenario gives an opportunity for global research collaborations beyond national borders. No wonder, the success of Meiji restoration in 19th century Japan also relied on opening-up.

Work for the greater good says Eric Rauchway while drawing lessons from the Great Depression of the 1930s. In the New Deal policy makers looked up to scientists to come up with practical ideas for social progress. This brought about productivity improvements because of technological innovations. There is a need, lest we forget, to keep in mind that the scientist should be locally grounded in his sensibilities and understanding of the problem as also the meaning of progress. It need not be material alone.

Scientists, however, have to Learn to convince politicians to protect their research budgets says Ian Taylor. This requires research-industry collaboration, this requires recognizing that innovation entails uncertainty as opposed to quantifiable risks. It should fulfil demand and not fund supply. One need not be a Keynesian to say this. This is a challenge for scientists/researchers. If they are worth their salt then they have to come up with practical successes. The catch of course is that the politician also has to learn to distinguish rabble-rouser's babble from matters of substance. They should learn to read (not listen) between the lines.

The final commentary is Jeffrey Sachs' Boost the developing world. The crisis which originated in the United States and Europe has very serious implications for the developing world. Investing in the poorest of poor countries, he says, is a triple win because it would provide a stimulus for richer countries, develop poorer countries and bring about environmental sustainability for all. The world on the verge of a climate change and food crisis with increasing incidence of hunger, if unaddressed, would lead to rising violence, disease, population displacement and most of all shrinking markets. The lesson for countries like India is to extend this poorer regions and vulnerable groups. Increase capabilities of the people, harness on their inherent enterprising nature.

Investing in the environment is Gail Whiteman's review of Sustainable Investing: The Art of Long-Term Performance by Cary Krosinsky and Nick Robins, Earthscan: 2008. I liked the review's opening sentence. "Money can't buy love. But can it buy a more sustainable world?"

Bill Emmott in his Old lessons for a new economics review's The Return of Depression Economics and the Crisis of 2008 by Paul Krugman, W. W. Norton: 2008; also available in Penguin. The reviewer indicates that the book does invoke Keyenesian thinking to be the need of the hour under current circumstances. However, as the book was initially written by keeping the crisis of the 1990s in mind and padded up by adding 11 pages to the current crisis there is scope for further elaboration.

One gets reminded of Gandhi's quote: "There is enough for everyone's need, but not enough for even one person's greed."

Economics needs a scientific revolution: a comment

The essay Economics needs a scientific revolution by Jean-Philippe Bouchaud has been published in 30 October 2008 issue of Nature 455, 1181, is stimulating and an interesting read. It points out the inability of mainstream economics or financial engineering to either predict or avert a crisis.

This outcome is a result of the huge divide between normative (theory) and positive (empirical) economics. In the process, as Bouchaud indicates, assumption have taken the form of axioms: rational economic agents maximize profits, each agent's pursuit of profit is also best for society and markets are efficient that through prices reflect all known information. At best, these results are about some ideal situations, which do not exist in real life. Striving for a particular ideal situation is one thing, but considering that the features of this ideal system are a part of the real life situation is another. It takes us to a belief system.

Adhering to a belief system can make updating of knowledge difficult. For instance, Tycho Brahe, who despite being credited for his accurate and comprehensive astronomical and planetary observations, could not entirely got out of the Geocentric model that the Earth is at the centre of the universe. It was his assistant, Johannes Kepler, who used the observations and came out with his three laws of planetary motion that conclusively showed that the Copernican system, Sun is at the centre, is correct.

There are no two opinions that a scientific inquiry requires a questioning mind. If required, questioning the very premises by cross checking with empirical observations. The reign of empiricism is in a Bayesian world. A minimum requirement for this is that your prior cannot be certain - you cannot begin with a belief system. The reason is that if your prior is either zero or unity, then whatever be your observation, your posterior will be equal to your prior (see my working paper Understanding Fundamentalist Belief Through Bayesian Updating. All empirical observations become irrelevant.

True, the models used by contemporary mainstream economics fail to explain how small perturbations can have 'wild' impacts. It is not true that fringe attempts by econo-physicists (including Bouchaud himself) and behavioural economists are not being taken seriously. Paul Ormerod's Butterfly Economics that followed the East Asian Crisis is a best seller (aside - most Economists may not know of this). Daniel Kanheman, a behavioural economist, received the Nobel in 2002. There have been some hiccups, but then many prominent economists have done work on asymmetric information, uncertainty and missing market that cannot be brushed aside.

Having largely agreed with Bouchaud, I point out some differences. First, inability to predict and avert a crisis cannot be a basis to gauge a discipline's success or failure. Just as the space shuttle Columbia's disaster on 1 February 2003 cannot be construed to be a measure of judging Aeronautics and Space research, the current financial crisis cannot be a measure of judging Economics. Crisis or disaster by nature is rare and not predictable. Like the violation of some safety regulations in the Columbia disaster the current global financial crisis, to put it simply, is an outcome of greed by some players who manipulated the markets for their advantages. Modelling apart, an economic system should have effective regulation to safeguard us against possible disasters.

Second, understanding the market with more appropriate tools and techniques of modelling is necessary, but it is more important to acknowledge that market is a tool, albeit, an important one. It is a means, but not an end in itself. This is the approach of the larger human development paradigm, which is people-centric.

Third, which in a way is related to the previous point, is that the dominance of utilitarianism, and hence, of markets in economics, was first successfully challenged by a prominent moral philosopher of the 20th century, John Rawls. He argued against the monoconcentration of utilitarianism and its associated formulaic reductionism in favour of plural concerns. On his concerns of justice his focus was on the least advantaged while assigning priorities to equal liberties and equal opportunities (that is, against arbitrary privileges). This is made possible by invoking the original position, that is, by putting decision makers under a veil of ignorance - they do not know which group they belong to. This in essence does away with vested interests. Thus, the silent scientific revolution, which goes beyond Economics, is already under way.