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By Steven Baker MP, on 16 March 12
Two days ago, Greg Smith, a Goldman Sachs executive director, resigned in sensational fashion, writing a column in the New York Times. In the article, he laid out the reasons for his resignation, citing the change in culture at the firm over the ten years he worked there. He wrote,
It might sound surprising to a skeptical public, but culture was always a vital part of Goldman Sachs’s success. It revolved around teamwork, integrity, a spirit of humility, and always doing right by our clients. The culture was the secret sauce that made this place great and allowed us to earn our clients’ trust for 143 years. It wasn’t just about making money; this alone will not sustain a firm for so long. It had something to do with pride and belief in the organization.
In particular, he attacked what he sees as the 3 ways to get ahead at Goldman Sachs:
- “persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit.”;
- “get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman”; and
- “Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym”
While the article might have been dismissed as one disillusioned ex-employee’s rant, it will ring all too true across the financial sector. The Motley Fool reports Goldman Isn’t Alone in the Delicate Art of Ripping Off People. After quoting some illustrative returns, fees and rewards in the industry, the author writes:
The clients that Goldman and the rest of Wall Street rip off are skilled at ripping off their own clients, thank you very much. Each is part of the same game of inflating expectations and overcharging fees — a system summarized best by the title of Fred Schwed’s classic book, Where Are the Customers’ Yachts?
And then he points out that the losers, the client’s clients, are people like you and me: savers, pension fund beneficiaries and retired schoolteachers. The article finishes by asserting that Goldman is just one example of “putting personal interests before clients.”
How did all this come to pass?
In 1999, just over ten years ago, Goldman Sachs went through a public listing. It had previously operated as a partnership but now it is majority owned by institutional investors.
Over on Forbes, an article explains the difference in incentives between a bank run as a partnership and one run as a traded corporation: the switch in incentives is from long-term success to short-term results. The author gives some persuasive arguments for the partnership model and says investment banks should be required to return to it. He finishes,
Real banking reform isn’t about lashing out, but about restoring the connection between bankers’ profits and the economy they serve.
Which is why, as part of my work on injustice in the financial system, I introduced my Financial Institutions (Reform) Bill. The Bill would minimise moral hazard within the financial system by ensuring that those who take risks are held personally liable for the consequences. It would realign bankers’ rewards, their risks and their actions in the real economy. I said,
Hard-working families and individuals paying tax out of typically modest incomes must never again suffer the injustice of carrying the risks, and consequences of risks, taken in the pursuit of often enormous private returns. Risks must fall to those who take them. Instead of vicarious liability of taxpayers, there must be responsibility in the banking system. The Bill represents an opportunity to free the banking sector and the public from regulatory capture and lobbying. It could raise standards from the bottom up, through the preservation and extension of commercial freedom and the development of professional, personal and mutual responsibility.
At the time, I had no idea that yesterday I would meet David Fishwick, founder of a savings and loans firm in Burnley, who is delivering just that. It began when he found people could not buy from his van business for want of credit, so he started making loans himself. He’s an entrepreneur, a self-made multi-millionaire from ordinary beginnings.
Channel 4 are now making a documentary about Dave’s attempts to start a decent bank which serves both savers and businesses. The Lancashire Telegraph reports,
“My bank may be tiny but it will be better than a high street bank. I want to show how banking can be socially responsible and not greedy and reckless and I’m going to do what the high street banks just can’t bring themselves to do, give away any profits to charity.”
The venture will see him guarantee and underwrite all the banking activity from his personal fortune.
It’s quite a rebuff to all those who told me no-one would run a bank if they had to put their own assets at risk. As I pointed out, some of history’s greatest bankers bore their own risks without limit. Now, Dave Fishwick is demonstrating that the basic business of banking — intermediating savings to entrepreneurs through productive loans — is an enterprise which individuals will back with their own wealth.
Dave’s banking business is small. The FSA essentially won’t meet him and no wonder: they make their money from fees levied on those they regulate. Dave’s business is presumably too small to cover the FSA’s costs. So he doesn’t have a banking licence, accepting savings and making loans on a different legal basis. His business, as he tells it, is based on his personal guarantee, trust and entrepreneurship. In the terms Hazlitt explained, credit is something people bring to Dave, through running profitable businesses, and that’s what enables him to make loans out of people’s precious savings, personally underwritten by him.
Dave Fishwick may yet fail. His business may be crushed out of existence by a dull and clumsy state. But I have said time and again that we need a new generation of local financial institutions which reconnect savers and productive businesses. It seems Dave is redeveloping the teamwork, integrity, spirit of humility and sense of “always doing right by our clients” which used to engender pride and belief amongst Goldman Sachs’ staff. There will always be a place for large, sophisticated firms but, together with ideas like Funding Circle, Dave’s enterprise may indicate that a new, more responsible and productive financial system is emerging spontaneously in society.
I look forward to watching the documentary in the next couple of months.
This article was previously published at stevebaker.info.
By Toby Baxendale, on 7 September 10
In an article yesterday I defined the only lawful way I know to create wealth as follows:
Wealth is only created when entrepreneurs make better goods and services, satisfying more of the needs of consumers, in better and more convenient and cheaper ways, via more capitalistic and hence more efficient methods of production. Both the capital investment and the subsequent purchase of the new goods and services should be supported by real savings (forgone consumption).
No amount of creating more money units itself produces more of the above. I would usually then say that we should seriously consider ending corporation tax so that companies can invest their own money in more capitalistic methods of production to produce more goods and services at cheaper prices that people want. This is a particularly salient point at this credit starved part of the business cycle, when banks are not lending. Through excessive taxation, the government makes companies reliant on debt financing. They then use this reliance to argue that the banks must be bailed out and supported with taxpayers’ money. Despite the massive public subsidy, banks are still reluctant to lend. Why not let the companies keep their own money, and finance themselves? We would see a growth-led entrepreneurial revolution.
Another positive step the government could take would be to abolish all copyright laws. Here is a very interesting article supporting the theory that the German Industrial Revolution was significantly propelled by the absence of copyright laws.
The legal theorist Stephan Kinsella highlights the German experience in his list of “Innovations that thrive without IP“:
According to Robert Groezinger, “This article in Der Spiegel is all about how the absence of copyright in Germany led to an “explosion of knowledge” in the 19th century. The reason there was no copyright law was that there was no central government until 1871. This contrasts with the UK, where there had been copyright since 1710, and the number of publications was lower by a factor of 10 compared to Germany. Also, the number of copies printed was much, much lower in the UK (hundreds as compared to ten thousand or so). The article claims that this is the main reason that Germany’s production and industry had caught up with everyone else by 1900.”
Radical times call for radical solutions, and abolition of corporation tax and copyright laws should be given serious consideration.
By Toby Baxendale, on 29 July 10
The Subjectivist Revolution in Economics Continues
Humans act and they act purposefully: this is the axiom of action proposed by Ludwig von Mises, teacher of Hayek. From this he claimed that the whole of economics could be deduced. As Mises shows, in order to be, we act purposefully. Not being, we would not act, indeed we would not exist. We act upon satisfying our most urgent needs first, then our second most urgent needs, and so on and so forth, ranking our preferences, with the most urgent needs/demands being satisfied first, the least urgent, and the furthest away in time. From this hierarchy we derive the law of demand, the downward sloping demand curve, the law of diminishing marginal utility (see here for a good illustration) and on and on it goes. Lord Lionel Robbins in a masterful 1932 book, The Nature and Significance of Economic Science shows in very clear terms how all the laws of Economics are derived from the a-priori thought process.
To try to refute it, you cannot, as you act purposefully to do so. Just as Pythagoras’s Theorem is implied in the concept of a right angle triangle – and we knew about the concept of the right angle triangle before Pythagoras “discovered” his Theorem – so, too, do the laws of economics flow from the one irrefutable axiom that humans act purposefully. It is a bit like saying Darwin “discovered” the Theory of Evolution, when what he actually did was articulate it and find very plausible data sets to help explain it to the sceptical mind. Evolution was always there.
So What can this Axiom tell us About Entrepreneurship?
When we act, we choose to satisfy our most urgent needs first, and we forego other opportunities which form our subjective costs. Action implies a sacrifice: what opportunity you forgo is your cost, and what you hope to gain is more than your cost: this is your entrepreneurial profit. This entrepreneurial profit does not have to be measured in money; it can be the choice between going to the theatre or staying at home and watching a TV program.
The entrepreneur is someone who is good at generating entrepreneurial profit, not only for himself but in the way he/she can help many more others in achieving and consuming the results of entrepreneurial profit. He is more alert at spotting opportunities that will satisfy people’s most urgent needs in quicker and in better formats, and for this he is rewarded usually with more money for his efforts.
According to Jesus Huerta De Soto in his book called Socialismo Calculo Economico Y Funcion Empresarial” 1992 soon to be published in English by Edward Elgar in Association with the IEA and called: “Socialism, Economic Calculation and Entrepreneurship” 2010, there are six characteristics of the information and knowledge that the entrepreneur captures to use to provide better goods and services to all in society.
Knowledge is Subjective and not Objective and Scientific
I have just watched my local farmer bring in a grass crop frantically in 3 days as he assessed a window of opportunity for him to do so, since rain was coming. He could not send this up to a State planner to make a decision for him – only his local knowledge about this particular time and circumstance, and his informed intuition regarding the weather could lead to this decision. He has crop that he can sell now. A planner in Whitehall would neither have all the information necessary nor respond quickly enough to make this all happen.
Knowledge is Exclusive and Dispersed
In my farmer example, this knowledge about when to bring the crop in is exclusively his and resides in him alone. In the same way, knowledge across the whole economy is broken up into little pockets of subjective knowledge held by millions of different people.
Knowledge is Tacit and it Cannot be Articulated
My farmer’s knowledge is tacit and in him, yet he probably cannot objectively articulate why he is doing it. Michael Oakeshott in “Rationalism in Politics”, 1962, gave us a very good example of a chef who is after all only following a formulaic procedure of putting together a recipe — add X of this to Y of that and cook at 200 degrees for 10 mins. But the instincts and unconscious background knowledge of an uber chef like Gordon Ramsey will allow him to produce outstanding food which I cannot hope to match simply by following the same recipe.
Entrepreneurship is Creative
There is no cost to an entrepreneurial idea, it is created ex novo. Bill Gates, when he created his first operating system, had his vision and his thought process, the idea, and then he got creating. Profits are thus created new and from nothing.
The Creation of New Information
Each creative new act of entrepreneurship creates new information which is used by others to profit them as well. A new software solution developed by the creative minds of Apple alerts all their users to new ways of doing things that benefit them in a quicker, faster and better way.
I recently had a conversation with a potential entrepreneur who has identified an abundant source of farm waste product that could be excellent for fish feed. If his business is developed, farmers will suddenly be made aware that what was once a cost can now be a source of revenue for him. Thus he will adapt his farming processes to now harvest this waste and costly product for profit. The fish farmers will eagerly await this new source of protein and adapt their newer and better buying accordingly.
The Transmission of Information
Although the price system is objective and allows the allocation of resources, the fish farmer does not need to know all the subjective information of the entrepreneur who has developed the new feed out of the farms’ waste, just that he can buy it. Likewise, the farmer does not need to know the detail of how it is going to be made useful to the fish farmer. All this knowledge is subjective and the briefest communication of it happens to facilitate trade.
Entrepreneurship is the foundation of society in that it insures the co-ordination of individuals’ behaviours. Without it, society would not exist.
Competition and Entrepreneurship
There is always a competitive and on-going process of rivalry and discovery as this society-wide coordination process happens. It is limitless and produces progress if left uninterrupted. It is the single most important process which unites society and permits its harmonious advancement.
The Division of Knowledge v the Division of Labour
The division of labour as suggested by Adam Smith shows us how, in a pin factory, if people concentrate on certain tasks and specialise, more production happens. This is an objective measure. Underneath this, and prior to it, is the subjective division of knowledge. In-depth knowledge is held in widely dispersed formats, often tacitly, precluding its articulation across society; thus it is impossible for any one person body or machine or government department to know all of this information. Also, only tiny amounts need to be communicated to make coordination in society possible. So Huerta De Soto introduces a new concept into the body of knowledge concerning economics: the universal division of knowledge that exists as a deduction from the axiom that humans act and takes the subjectivist revolution started by Menger into our very understanding of the division of labour. He also moves man on from being the Robbinsian homo oeconomicus to the homo empresario. Acting man is entrepreneurship.
Once again Huerta De Soto has given some great new insights into economics in the field of economics. He has stood on the shoulders of Adam Smith, Mises, Hayek and Kirzner to great effect to knock the objective division of labour off its pedestal and put in its place the division of knowledge. This is what Einstein did to Newton in physics. Both still have their place, but the latter being of more fundamental importance.
By Toby Baxendale, on 22 March 10
Do you think it is very worrying that not one government policy encourages the entrepreneurs of the world to create wealth?
Without wealth creation we are doomed to a long slow decline in the productive capacity of the economy. We are doomed to the stagnating to slow growth economy that all the policies of our Great Leader, Gordon Brown, is inflicting upon us. It is all because he does not understand how wealth is created and the role of entrepreneurship in society. Most politicians are the same, I am afraid to say, with a few shining lights and notable exceptions. This is desperately worrying for all of us.
How is Wealth Created?
I have said here on this site before http://www.cobdencentre.org/2009/09/can-the-manipulation-of-interest-rates-create-wealth/ “I would like you to absent the concept of money and consider a situation of barter. As a butcher, when I kill an animal, I may get for the sake of argument, 10 cuts of meat: this is my production. I only need 2 for my immediate consumption, so with the remaining 8 cuts, I trade with Andrew, a garment manufacturer, for some garments to keep me warm. I consume 2 cuts and I save 8 cuts in order to trade for other goods and services. I need to produce to consume: I need to save/invest to consume.
“If I wish to consume more of Andrew’s garments as I have a family to dress and keep warm, 8 cuts of meat may well not be enough to purchase these new needs and requirements of mine. At this point in time, I am faced with a choice, either my production has to increase so I can generate more cuts to exchange for other goods, or I accept my fate and stay where I am. I decide that I can invent a method of cutting up the parts quicker by using a sharper knife, thus I seek to invent the “steel” or knife sharpener that improves my productivity from generating 10 cuts in a day to 15. With these 5 extra cuts, I can get more garments.
“The problem is, that in order to get the steel built, I need to spend some of my time that would be making the 10 cuts. Thus, I have to save and forgo some consumption while I have the steel built. I also have to rely on my savings — those stored cuts of meat — that I have not consumed to keep me afloat. This is what an economist may mean when he says adding capital to an economy lengthens the structure of production. The steel in this example adds a stage to the capital structure of society, to make me more productive, so I can consume more things.
“To be clear, saving is the only thing that allows this to happen. In this example, my personal capital structure has gone from me with a knife in my hand consuming two cuts a day and exchanging 8 saved portions, to me and a knife and a steel to produce 15 cuts of which I consume 2 and exchange 13 saved cuts. Now Andrew will be doing the same, i.e. lengthening his structure of production to meet my new found desires for more goods. He will also have to save — i.e. forgo consumption — to invest with the sustenance that savings gives him, to become more “capitalistic” or capital intensive in his production structure, to meet my demand.”
In summary, during the passage of time, only an act of saving to invest in a longer capitalistic method of production can lead to more goods and services being produced and consumed. No amount of creating money out of thin air creates more goods and services.
The Austrian School Role of the Entrepreneur in Economics
Humans Act
One of the great contributions of Ludwig von Mises to our understanding of the world, in his book ‘Human Action’ is that humans act and they act purposefully to satisfy their most urgent needs and requirements. Absent action and you would not have a moving human society, but a static world with no existence at all. We rank our most immediate preferences first and our most remote preferences last, thus we always have a downward sloping demand curve for things.
Sub Categories of Action: the Entrepreneur
All men act, they are in economic theory either an entrepreneur, a capitalist, a landowner, a worker or a consumer. These are ideal types, ideal styles. The reality is that we are all a combination of more than one of the above.
In the real world everybody is an entrepreneur except the children and elderly we look after, and wards of state that we pay in various forms to do nothing, such as the unemployed and those on incapacity benefit.
Israel Kirzner shows us in his books ‘Competition and Entrepreneurship’ and also in ‘Perception, Opportunity, and Profit’, how the spontaneous discovery of new opportunities by alert individuals is a defining characteristic of entrepreneurship. For example, a man who is more alert than another to satisfying the most urgent needs and requirements of other men, such as Bill Gates in inventing Microsoft and its worldwide and world changing software is rewarded by his fellow consumer entrepreneurs more so than the man who comes and fixes the boiler as he is providing a more valuable and needed service. Gates’s unique ability over the years to be alert to the potential opportunity, to think, to create to make happen, makes him the richest man in the world.
The Economy as Dynamic Creative Process
De Soto, in his books ‘The Theory of Dynamic Efficiency’ and ‘The Austrian School, Market Order and Entrepreneurial Creativity’ shows us that as the economy is predicated by acting man seeking ways to satisfy his most urgent needs and requirements first, and with limited resources, everything in politics should be geared to letting the full creative talents of the most humble entrepreneur to the giants on entrepreneurship flourish. Past Popes such as John Paul the II and Leo XIII, in ‘Centesimus Annus’ and ‘Rerun Novarum’ have been wonderful in expressing the moral ethic of human being s able to express our own creativity unhindered so long as we hinder no one else.
To our current political class, astonishingly, it is never about creating, but about distributing: X, the group of more deserving persons, is going to get Y taken from them, and it will be promptly redistributed to the less deserving class. In most cases the less deserving class is the successful entrepreneur who has satisfied the most urgent needs of consumers the most and been rewarded for doing so by his consumers!
How the Political Class Understands Economics: the Neo-classical Way
Lord Lionel Robbins, a great early Austrian School economist from the LSE, sadly left us with a very negative legacy concerning entrepreneurship in his otherwise exceptional book, ‘An Essay on The Nature and Significance of Economic Science’. My copy is online here, http://mises.org/books/robbinsessay2.pdf This would be the starting point marking when economics is described as the science which studies the utilisation of scare resources which may be put to alternative uses in order to satisfy human needs. So the economic problem is a technical one of allocation.
This contrasts with the real world creative dynamic actors who are constantly alert to creating new means to satisfy new ends by using all their creative talents and those of others they can muster in order to satisfy the largest number of ends. This is entrepreneurship as a discovery process. No economics is about choosing between competing uses to satisfy set ends.
In the Neoclassical world – and we must remember the School of Keynes and Friedman, the Keynesians and the Monetarist are but subsections of the Neoclassical School – it is impossible for there to be pure entrepreneurial profit or genuine discovery, as they are enclosed in a world where there is call for intervention in the distribution of scarce resources. Technical allocation is the height of the Neoclassical Mission. The man who ‘discovers’ the wheel, the internal combustion engine, the computer etc are all acts of great creativity and are examples of where pure entrepreneurial profit is generated. To the technician/administrator/bureaucrat/resource allocator of the Neoclassical School, there is no role for this, but when it does happen, lo and behold there is a role of how to technically allocate its benefits!
The Role of Knowledge and Information
I was fortunate to study under Dr Robert Orr at the LSE who was a protégé of the outstanding political philosopher, Michael Oakeshott. I will never forget my first introduction to his 1962 classic book, ‘Rationalism in Politics’, where Oakeshott cleverly distinguished between “practical knowledge” and “scientific knowledge.” The former he describes as the dispersed know-how that we all have that allows us to do things that cannot be formalised, like the tacit knowledge a cook has when he/she cooks a fantastic dinner. Putting the food together in various combinations and heating for various times are, after all, simple acts that could be described in a very formulaic fashion. But how many of us have that practical, unquantifiable knowledge to cook an outstanding dinner? The former, formulaic knowledge, is the scientific knowledge or technical knowledge that we can formalise such as the knowledge of science itself. The study of entrepreneurship or economics in general is about the study of which entrepreneurs use this practical knowledge to bring about co- ordination and more goods and services by doing more things to satisfy more people. Scientific knowledge may boost this process as entrepreneurs exploit the information that the scientific knowledge produces. The danger is when the people who study economics and the application of entrepreneurship or the use of this dispersed practical knowledge or know how think they can scientifically manage it.
Harmony / Coordination and not the Creative Destruction of Schumpeter
Technical direction by the ‘enlightened’ entrenched administrators who dominate large parts of our lives is no match for the co-ordinating forces of entrepreneurship. The price mechanism throws up information that suggests opportunities to alert entrepreneurs to supply goods and services or solutions to satisfy peoples’ most urgent needs. This co-ordination can never be facilitated by administrators. Each time a profit opportunity is found and then satisfied, a creative and co-ordinating act has happened. Entrepreneurship is coordination. Each act of entrepreneurship in fact smoothes out dis-co-ordination in society. It is the most civilising act. This is very different to the creative destruction of Joseph Schumpeter who, in ‘Capitalism , Socialism and Democracy’ says that entrepreneurs enter established industries that start to exercise some monopoly power, thus allowing a smaller, nimbler competitor to enter and value-destruct and then value re-create something new and better. Schumpeter, unlike his Austrian contemporary, Mises, viewed booms and busts to be caused by innovation and not by excessive credit creation.
The Austrian Approach
So for the Austrian, we all act to satisfy our ends. Some do it better than others, some do it to many others, and these latter entrepreneurs are, in truth, the dynamic, creative, co-ordinating and above all harmonious drivers of the economy and facilitators of a peaceful society. This is in direct contrast with the homo oeconomicus of Robbins and the Neoclassical School, whose modern members are Keynesians and Monetarists. Resource allocation between competing needs is the name of their game.
They conflate scientific knowledge with the practical. This allows them to advocate constant spending by a thing they describe as a third party: Government. Government is meant to inject new money into the economy to get us all moving again. There is a horrible inevitability here: like a Greek tragedy, it is played out on epic proportions. There is no such thing as a government standing above and separate from us that can stimulate us. The government can only take from one section of the population and give to other sections of the population. When they spend money, they are spending the money you would have spent. The positive government spending multiplier is exactly negated by the negative spending multiplier from where the government has extracted the money in the first place. The net effect is zero extra spending. However. It does not stop there. For a great dis-co-ordination in the practical knowledge of people will take place when a government spends as the entrepreneurs will now be confused as to which activity in the economy will produce a sustainable outcome. Which bits of price information are driven by the most urgent needs of consumers that needs satisfying? Which are driven by the technical director of some government department directing who he thinks – or his political master thinks – the given set of resources should be allocated?
We are told we should print more money. I tell no lie, I witnessed one economist, Roger Bootle, see here http://www.cobdencentre.org/2010/02/policy-exchange-and-the-near-consensus-on-the-merits-of-qe/ say we should, if need be, print money indefinitely until people knew we were so serious that we would not allow a deflation! He equates a growing money supply with more wealth. But a growing money supply without more goods and services means a lowering of each money unit’s purchasing power! This has nothing whatsoever to do with the creation of wealth, as I have demonstrated above. Both endless spending and endless printing of money are the policies of the mystic and witch doctor!
In conclusion,the correct and urgent policy for the political class must be to remove all restrictions on the ability of each person to use their best entrepreneurial endeavours. Each person can then take advantage of the practical knowledge that is out there and create, ex novo, new combinations of the factors of production to produce new things. Abolish all laws that prevent and hamper business unnecessarily; pro-union legislation; employment law excesses; presumption of guilt by you, the employer, for anything your staff does, thus absenting you from any individual responsibility. Stop paying the people who abuse the benefit system, who form the massive, larger than the army size workforce we have idle on unemployment and or incapacity benefit. Stop wasting resources going to war. Stop printing money and creating confusion as it is harder for an entrepreneur now more than ever to distinguish between what is or is not a bubble supported activity that is never going to be sustainable. This latter disruption in the co-ordinating ability of entrepreneurs to bring about economic harmony is the worst part of the legacy that this current government will gift the next.
Until they understand the nature of entrepreneurship, we are in for a prolonged and rough recession.
By Steven Baker MP, on 11 February 10
Our Founder and Chairman’s fish supply company, Seafood Holdings, came 12th in the weekend’s Sunday Times Fast Track 100 Buy Out League profits table:
Although the results show 2008 and not 2009, the continuing dedication to sound entrepreneurship that drives our Chairman continues apace and we wish Toby all the best in his endeavours.
By Steven Baker MP, on 17 December 09
Via FT.com / US / Economy & Fed – Fed signals pullback in liquidity supports, we learn:
The Federal Reserve on Wednesday upgraded its assessment of the US economy and highlighted its intention to shut down most of its crisis-fighting liquidity facilities in early 2010.
And consequently:
Stocks eased slightly after the Fed statement, while the yield curve in the bond market steepened.
Which brings us on to Roger Koppl’s Big Players and the Economic Theory of Expectations.
I am indebted to Cobden Centre supporter Bruno Prior for introducing me to Koppl’s work which extends the tradition of Ludwig von Mises, Friedrich Hayek and others, unusually, applying empirical methods to demonstrate the application of the theory.
Koppl demonstrates, with extensive reference to other scholars, that investment and all other economic actions depend on “subjective” expectations. He then presents a theory of expectations which assumes people interpret their situations in unpredictable ways. This theory includes a theory of “Big Players”:
Big Players are privileged actors who disrupt markets. A Big Player has three defining characteristics. He is big in the sense that his actions influence the market under study. He is insensitive to the discipline of profit and loss. He is arbitrary in the sense that his actions depend on discretion rather than any set of rules. Big Players have power and use it.
We learn that Big Players reduce the reliability of expectations, thereby disrupting markets. They encourage herding and produce perverse effects on entrepreneurship: traders must pay attention to the Big Player and not the fundamentals.
And so we find today, for example, the markets moving in response to the Fed not the realities of the economy…
By Steven Baker MP, on 17 November 09
Via ConservativeHome, excellent comment from Jamie Murray Wells, founder and Executive Chairman of Glasses Direct, the world’s largest online retailer of prescription glasses:
A rich entrepreneurial spirit flows through Britain. Thousands of new businesses are successfully established here each year. But the response this Government is proposing to our current economic mess will certainly not benefit the entrepreneurs of tomorrow.
Entrepreneurs are job creators and a fiscal environment that supports entrepreneurial activity is good for the whole UK economy, but the tax rises Gordon Brown says he needs to fund the stimulus and fend off rising unemployment, will in fact do the opposite. And while Brown has been increasing the public sector workforce at the expense of private sector jobs, Mandelson has been renewing the old Labour habit of using taxpayers' money to “pick winners“. The historical record of that policy is disastrous.
By Steven Baker MP, on 12 November 09
Via the Quarterly Journal of Austrian Economics, our Chairman, Toby Baxendale, and our Founding Fellow, Dr Anthony J. Evans further the monetary theory of the trade cycle:
We contribute to the debate over the contemporary relevance of the Austrian Business Cycle theory (ABC) by making three theoretical developments.
First, we claim that the heterogeneous nature of entrepreneurship is the best means to respond to a Rational Expectations (RE) critique. If entrepreneurs are different then the “cluster of errors” are not made by everyone, just those on the margin. And if the marginal entrepreneurs are systematically different from the population as a whole, we avoid the implication of widespread irrationality, even though credit expansion will affect real variables.
Second, we argue that the size of the monetary footprint is a more telling signal than the market rate of interest, and will not necessarily be revealed by measured inflation. Therefore attention to the official interest rate or Consumer Price Index is misleading, and an inappropriate way to assess applicability.
And third, the main harm from loose monetary policy is not that it encourages entrepreneurs to behave more recklessly with capital, but that it encourages precisely the people who can’t afford capital at the market rate to borrow, and makes them the marginal trader.
This suggests that adverse selection is a more important issue than moral hazard. We acknowledge that empirical work is required to verify these claims, and suggest how this might be undertaken.
The article includes a recap of the theory. Read more.
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