Today on the podcast. Ethics in economics. Similar to intelligence in peat moss. We have some instructive excerpts from a recent Booth School seminar. Also a nod to a paper from the Brookings Institute analyzing the difference in statistical description of the economy between what are supposed to be mirror images of one another -- GDP and GDI -- Gross Domestic Product and Gross Domestic Income
First, it's becoming more and more obvious that the EU's bailout of its banks and IMF style prescription of austerity for sovereigns in debt difficulty is not convincing even to the markets who demanded it. The euro slid this morning to a four-year low. "Contagion" is the word of the day. Contagion through financial markets, the hysterical matrons of the economic structure. Until we operate the financial sector for the benefit of the real economy rather than the other way around, we're going to pitch from one crisis to another. Look for a short interview with Joseph Stiglitz on the blog tomorrow.
As Martin Wolf recently put it,
I have now lost faith in the view that giving the markets what we think they may want in future – even though they show little sign of insisting on it now – should be the ruling idea in policy.Elsewhere, from the Brookings Institute, a new paper entitled
The Income- and Expenditure-Side Estimates of U.S.
Jeremy J. Nalewaik
begins with this Abstract:
The U.S. produces two conceptually identical official measures of its economic output, currently called Gross Domestic Product (GDP) and Gross Domestic Income (GDI). These two measures have shown markedly different business cycle fluctuations over the past twenty-five years, with GDI showing a more-pronounced cycle than GDP. The goal of this report is to determine which measure better reflects the business cycle fluctuations in “true” output growth, and a broad range of results favor GDI. GDI currently shows the 2007-2009 downturn was considerably worse than is reflected in GDP.This is something we warned you about some time ago, with a heads-up via macroblog out of the Atlanta Fed.
As the report says, GDI has a different name than GDP, so it may not be initially clear that GDI measures the same concept as GDP, using the equally valid income approach. But the income approach and official GDI indicates a more severe and still lingering recession.
If we were to apply the perspective of the Sarkozy Report which we covered in a series of reports not too long ago, which would isolate median personal or household income to produce a number corresponding to a real person, Demand Side suspects you would see an even deeper and more difficult situation.
And then subtract the immense economic bad of the Deepwater Horizon Gulf oil catastrophe, and you would see that 2010 is not shaping up as such a very good year
Ethics in economics.
From of all places, the Booth School at the University of Chicago. In a recent seminar, Luigi Zinales, Tobias Moskowitz and Steve Kaplan presented some perspectives on ethics from the economics point of view. I'm going to take a lot out of context, but provide enough, I hope, to show you that economists have no idea about ethics because their point of view is self-interest. Five thousand years of ethical discussion has never found a contract that makes it in your self-interest to do what is good for everybody. Ethics presumes a willingness to do what is good for the whole, with the idea that this is the right thing to do.
Let's begin with Luigi Zingales. This clip begins just after he tells the story of a sociologist who spent a year in the 1950s studying a town in southern Italy, extremely backward, which fails to prosper because of intense self-seeking on the behalf of each family.
Now we come to Steve Kaplan, who offers the most cogent advice.
How extremely naive to say that by thinking deeply about one's true long-term self-interest one will be brought back to the ethical by concern for reputation. An wholly forced way of trying to capture ethics with improbable self-interest bait.
The appropriate relationship between a professional and his client is what is called the shared aim relationship. The professional operates in the interests of his client. He is compensated for his time and education and skills and so forth. A doctor operates ethically when he provides the services that create the best level of health in his patient. A lawyer operates ethically when he provides the level of service and type of service that makes his client better off. So there is the transactional component, an aspect of another, what is called mutual benefit relationship.
But you can quickly come up with the systemic problems that make a doctor better off if he conducts more or more complicated procedures. A lawyer can be much better off providing a lengthy service than settling at the outset. But in economics, and particularly in finance. Performance bonuses, portfolio management selections, and basically the whole gamut of recent banking and shadow banking practices of recent years, divorced the interests of the banker from those of his client in the matter of risk. This is the agency problem, where the agent collects big time in the case of gain, but loses little in the case of loss. The client -- not so much. Yet the client will not go with the low return agent in many cases because of not being able to see the future. In 2007, how many of us were fools for not having bought a house in 2000 and collected the huge equity increase?
I'm going to run an extended excerpt from the person with whom I most fervently disagree on this panel just to show you how shadow bankers are captured in a situation where the professional position is inherently at odds with ethical outcomes. I think this demonstrates why vanilla banking has to come back, the shadow banking system is the road to ruin, and why the economists first rule of ethics -- don't do anything illegal -- has to be the benchmark for the society trying to protect itself. That is, we have to structure these activities so that the shared aim is easy to see and the activity that damages the civic capital in Zingales terms, is illegal.
I thought the illustration of the dangers of creating liquidity out of illiquid assets was quite instructive. It creates basically an unworkable ethical situation.
These three speakers -- catch the full Monty at the Booth School podcasts -- illustrate clearly that me-first self interest is inherently at odds with ethics. Teachers, firemen, policemen, musicians, and many others have made choices not based completely on their financial self-interest, recognizing that financial self-interest is in some sense hollow and primitive. They operate on a sense of self-interest that includes the people for whom they work. The great economists of all times have not spun their theories or advocated for them based on how much money they could make or how they would look to their peers. To have the discipline basically taken over by the idea that the highest good for me will somehow come out to be the highest good for everybody by the magic of the invisible hand is disgraceful.
But in our own self interest here at Demand Side, and perhaps the interest of providing better quality and more diverse products, we are going to cut back on the podcasts. Only one per week for the summer at least. Look for them on Tuesdays.