[Editor’s note: Tim Price, London-based wealth manager, is filling in for Simon today.]
JW: “..Someone like Neil Woodford, star investor, who set up his own fund; he says the fundamentals of the economy will be unmoved [by Brexit] either way..
RA: “Well I’m afraid that every, every serious economic forecaster would not agree with that..”
JW: “Are you saying he’s not serious?”
RA: “Not for economic forecasts, clearly.”
JW: “He’s an investor on behalf of pensioners.”
RA: “I’m talking about every major economic forecaster. A weaker economy means lower wages, lower profits, lower dividends, lower investment returns and lower pension contributions as well as lower pension fund investments. This isn’t some kind of conspiracy, this is consensus here… What do pensioners want more than anything else? They want certainty.”
– Today presenter Justin Webb discussing Brexit pensionocalypse with Baroness Ros Altmann, 27 May 2016.
Carve-up, n. “An act or instance of dishonestly prearranging the result of a competition.”
Just two hours before it was barred from issuing any more fatuous propaganda about Brexit, the UK Treasury last week managed to surpass themselves. They warned that if the UK left the EU, the hit to each individual British pensioner would amount to £137 per year. Those with an additional pension pot worth £60,000 would apparently be worse off to the tune of £1,900. (The “forecasts” arrived conveniently alongside news that net migration into the UK had risen to a third of a million people in 2015.)
Economist (UCL, LSE) and pensions minister Ros Altmann was duly wheeled out to defend this nonsense. The interview on Radio 4’s Today programme was entertaining, if nothing else. Memo to Planet Altmann: pensioners may want certainty, but they’re not going to get it, in or out, no matter how confident you are in the “forecasts” of economics bodies like the IFS, the OECD, the NISR [National Institute of Statistics Rwanda?], the IMF, the Bank of England, the LSE.. Just when you thought it was impossible for the fractious Brexit debate to plumb new depths, Ros Altmann got her spade out. Rubbishing fund manager Neil Woodford because he doesn’t happen to swallow the government line about Brexit triggering economic and financial market meltdown is simply ridiculous. The phrase “credible economic forecasts” carries as much intellectual weight as phrases like “military intelligence”. The British economist Joan Robinson was surely right when she observed that
The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.
Modern economics has a long and inglorious history of believing its own PR.
Conventional (neo-Keynesian) economics is a bastard science. It is not, in fact, a science at all. When the Frenchman Léon Walras, who had serially failed at every job to which he had previously turned his hand, walked with his father one evening in 1858, he was advised by Walras Sr. to have a crack at “the creation of a scientific theory of economics”.
Walras Jr. had previously botched careers in academia, engineering, creative writing, journalism, and banking. That he had been rejected, twice, from France’s prestigious Ecole Polytechnique due to poor mathematical skills tells you everything you need to know about the birth of modern economics.
But Walras Jr. did not give up. Rather, he flunked again. Before Walras, economics had not even been a mathematical field. Eric Beinhocker in ‘The Origin of Wealth’ takes up the story:
Walras and his compatriots were convinced that if the equations of differential calculus could capture the motions of planets and atoms in the universe, these same mathematical techniques could also capture the motion of human minds in the economy.
In other words, Walras hijacked a bunch of principles from the realm of physics and then misapplied them to a grotesquely oversimplified model of his own economy. Modern economics, in other words, was born out of physics envy.
Walras was not alone. Beinhocker points out that he was “not the only economist during his era raiding physics textbooks in search of inspiration”; the British economist William Stanley Jevons is also cited for ‘borrowing’ from the theories of gravity, magnetism and electricity in an attempt to turn economics into a mathematical science.
It isn’t, and never can be.
We have involved ourselves in a colossal muddle,
wrote the British economist John Maynard Keynes in his essay ‘The Great Slump of 1930’;
..having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time.
Keynes was right to warn about the baleful prospects for wealth. The Great Depression would run on for the best part of a decade.
But words matter, and their meanings matter. Keynes’ metaphor of economy-as-machine is not just inaccurate, it’s inappropriate. The economy is not some simple machine that can be driven back to equilibrium (an illusory state that doesn’t even exist in the real economy). The economy is as complex as human nature because the economy is human interaction on a global scale. The economy is us. And by extension, the financial markets are us, too.
Keynes would be proven right about the slump in wealth. But the ‘economy as a machine’ metaphor is invalid, just as Walrasian economics is invalid. The great insight of the so-called Austrian or Classical economic school, inspired by the likes of Ludwig von Mises and Friedrich Hayek, is that the economy is far too complex to be compared to a simple mechanism. The economy is subject to all of the hopes, fears, frailties and illogicalities of human beings. Good luck modelling that.
Not that it has stopped economists from trying.
A key prediction of traditional economics, for example, is that the economy as a whole must at some point reach equilibrium – a prediction made by both the general equilibrium theory of microeconomics as well as by standard macroeconomics. So how long does it take for the economy to reach that equilibrium?
In the 1970s, the Yale economist Herbert Scarf determined that the time to equilibrium scales exponentially with the number of products and services in the economy to the power of four. The intuition behind this relationship is straightforward: the more products and services, the longer it takes for all the prices and quantities to adjust.. if we optimistically assume that every decision in the economy is made at the speed of the world’s fastest supercomputer (currently IBM’s Blue Gene, at 70.72 trillion floating-point calculations per second), then using Scarf’s result, it would take a mere 4.5 quintillion years (4.5 x 1018) for the economy to reach general equilibrium after each exogenous shock. Given that shocks from factors such as technological change, political uncertainty, weather and changes in consumer tastes buffet the economy every second, and the universe is only about 12 billion years old (1.2 x 1010), this clearly presents a problem.
The essential problem of traditional economics is that it assumes a largely closed system of, in Eric Beinhocker’s words, incredibly smart people in unbelievably simple worlds. The reality, as objective non-economist modern commentators tend to agree, is that the economy is closer to being a complex, adaptive, dynamic system – not unlike a living organic being, vulnerable to illnesses and other sudden exogenous outbreaks.
The yin to Keynes’ yang is the great Austrian economist Ludwig von Mises. As part of his magnum opus, ‘Human Action’, Mises wrote about the impossibility of economic calculation in the centrally planned economy:
The paradox of “planning” is that it cannot plan, because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark. There is no question of a rational choice of means for the best possible attainment of the ultimate ends sought. What is called conscious planning is precisely the elimination of conscious purposive action…
The mathematical economists are almost exclusively intent upon the study of what they call economic equilibrium and the static state. Recourse to the imaginary construction of an evenly rotating economy is, as has been pointed out, an indispensable mental tool of economic reasoning. But it is a grave mistake to consider this auxiliary tool as anything else than an imaginary construction, and to overlook the fact that it has not only no counterpart in reality, but cannot even be thought through consistently to its ultimate logical consequences. The mathematical economist, blinded by the prepossession that economics must be constructed according to the pattern of Newtonian mechanics and is open to treatment by mathematical methods, misconstrues entirely the subject matter of his investigations. He no longer deals with human action but with a soulless mechanism mysteriously actuated by forces not open to further analysis. In the imaginary construction of the evenly rotating economy there is, of course, no room for the entrepreneurial function. Thus the mathematical economist eliminates the entrepreneur from his thought. He has no need for this mover and shaker whose never ceasing intervention prevents the imaginary system from reaching the state of perfect equilibrium and static conditions. He hates the entrepreneur as a disturbing element. The prices of the factors of production, as the mathematical economist sees it, are determined by the intersection of two curves, not by human action.
Keynes was looking for a lever to move the economy. But the lever does not exist. The economy as machine does not exist. The metaphor he used is not grounded in objective reality.
We do not know precisely what might happen if the UK were to vote to leave the EU. It is intellectually and morally unacceptable for economists to pretend that they do.
Notwithstanding Ros Altmann’s hypothetical pensioners and the hypothetical behaviour of post-Brexit financial markets, doubt may be uncomfortable, but certainty is absurd. The tone and content of the Brexit debate, thus far, has been a disgrace – and the economists are amongst the guiltiest parties.