Economics: The User's Guide

Self-seeking itself is too simplistically defined, with the implicit assumption that individuals are incapable of recognizing long-term, systemic consequences of their actions. Some European capitalists in the nineteenth century argued for a ban on child labour, despite the fact that such regulation would reduce their profits. They understood that continued exploitation of children without education would lower the quality of the workforce, harming all capitalists, including themselves, in the long run. In other words, people can, and do, pursue enlightened self-interest.

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Emphasizing the importance of ‘real’ choices is not to suggest that we can make any choice we like. Self-help books may tell you that you can do or become anything if you choose to. But the options that people can choose from (or their choice sets) are usually severely limited. This could be because of the meagreness of the resources they command; as Karl Marx dramatically put it,

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The economists’ favoured measure for output is Gross Domestic Product, or GDP. It is, roughly speaking, the total monetary value of what has been produced within a country over a particular period of time – usually a year, but also a quarter (three months) or even a month.

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In this case, that something is the used-up parts of capital goods – basically machines, so we are talking the baker’s ovens, dough mixers and bread slicers. Capital goods, or machines, are not ‘consumed’ and incorporated into the output in the same way in which flour is to bread, but they experience reduction in economic value with use – this is known as depreciation. If we take away the wear and tear of machines from GDP, we get Net Domestic Product, or NDP.

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To deal with this problem, economists have come up with the idea of an ‘international dollar’. Based on the notion of purchasing power parity (PPP) – that is, measuring the value of a currency according to how much of a common set of goods and services (known as the ‘consumption basket’) it can buy in different countries – this fictitious currency allows us to convert incomes of different countries into a common measure of living standards.

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Positional goods are goods whose values derive from the fact that only a small proportion of potential consumers can have them.

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The issue of false consciousness is a genuinely difficult problem that has no definite solution. We should not approve of an unequal and brutal society because surveys show that people are happy. But who has the right to tell those oppressed women or starving landless peasants that they shouldn’t be happy, if they think they are? Does anyone have the right to make those people feel miserable by telling them the ‘truth’? There are no easy answers to these questions, but they definitely tell us that we cannot rely on ‘subjective’ happiness surveys to decide how well people are doing.

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While it is an extreme example, Equatorial Guinea’s experience powerfully illustrates how economic growth, that is, the expansion in the output (or income) of the economy, is not the same as economic development.

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In the early nineteenth century, factory productivity was further raised by lining up the workers in accordance with the order of their tasks within the production process. The assembly line was born. In the late nineteenth century, the assembly line was put on a conveyor belt. The moving assembly line made it possible for capitalists to increase the pace of work simply by turning up the speed of the conveyor belt.

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The most important in this regard was Taylorism, named after Frederick Winslow Taylor (1856–1915), the American engineer and later management guru. Taylor argued that the production process should be divided up into the simplest possible tasks and that workers should be taught the most effective ways to perform them, established through scientific analyses of the work process. It is also known as scientific management for this reason.

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The mass production system, a century after its invention, still forms the backbone of our production system. But since the 1980s it has been taken to another level by the so-called lean production system, first developed in Japan.

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In order to be used, most technologies have to be embodied in fixed capital, namely, machines and structures (e.g., buildings, railways). So, without high investment in fixed capital, technically known as gross fixed capital formation (GFCF),* an economy cannot develop its productive potential very much. Thus, the investment ratio (GFCF/GDP) is a good indicator of its development potential. Indeed, the positive relationship between a country’s investment ratio and its rate of economic growth is one of the few undisputed relationships in economics.

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The share of manufacturing both in output and in employment was almost constantly rising in most countries. However, from the 1960s, some countries started experiencing deindustrialization – a fall in the share of manufacturing, and a corresponding rise in the share of services, in both output and employment.

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Contrary to conventional wisdom, development of productive capabilities, especially in the manufacturing sector, is crucial if we are to deal with the greatest challenge of our time – climate change. In addition to changing their consumption patterns, the rich countries need to further develop their productive capabilities in the area of green technologies. Even just to cope with the adverse consequences of climate change, developing countries need to further develop technological and organizational capabilities, many of which can only be acquired through industrialization.

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The most important types of funds include: pension funds, investing money that individuals save for their pensions; sovereign wealth funds, which manage state-owned assets of a country (Government Pension Fund of Norway and Abu Dhabi Investment Council are two of the biggest examples); mutual funds or unit trusts, which manage money pooled by small individual investors that buy into them in the open market; hedge funds, which invest actively in high-risk, high-return assets, using a pool of large sums given to them by very rich individuals or other, more ‘conservative’, funds (e.g., pension funds); private equity funds, which are like hedge funds, but make money solely out of buying up companies, restructuring them and selling at a profit.

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Derivatives are so called because they do not have any intrinsic value of their own and ‘derive’ their values from things or events external to themselves, in much the same way in which someone in Manchester can derive value from a boxing match in Las Vegas by entering into a bet on it with a bookmaker or even a friend.3 You could say that derivatives are bets on how

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Derivatives contracts may be ‘standardized’ and sold in exchanges, or become exchange-traded – the Chicago Board of Trade (CBOT), set up in the mid-nineteenth century, being the most important example. In the case of a forward, it is re-christened when standardized – these are called futures. An oil futures contract might specify that I will buy from whoever happens to hold that contract, say, in a year’s time 1,000 barrels of a particular type of oil (Brent Crude, West Texas Intermediate, etc.) at $100 a barrel.

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The point is that, however deftly you may pool, structure and derive your financial products, it is in the end the same subprime mortgage borrower in Florida, the same small company in Nagoya and the same guy who borrowed money to buy his car in Nantes who have to pay back the loans that underlie all those new financial products. And by creating all sorts of financial products that link different bits of the system, you actually increase the intensity with which the failure by these people to repay their loans affects the system.

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The rise of the ‘shareholder value maximization’ model in the era of new finance has dramatically reduced the resources available for long-term investments

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Today we have – and started demanding through regulation – those things exactly because we have cars that are powerful and fast but that can do a lot of damage if something – even a small thing – goes wrong. Unless the same reasoning is applied to finance, we will keep having the economic equivalents of car crashes, hit-and-runs or even motorway pile-ups.

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The most reasonable conclusion to draw from the review of various theories and empirical evidence is that neither too little nor too much inequality is good. If it is excessively high or excessively low, inequality may hamper economic growth and create social problems (of different kinds).

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With these disadvantages, the poor find it difficult to win the race even in the fairest of markets. But markets are routinely rigged in favour of the rich, as we have seen from a series of recent scandals surrounding deliberate misselling of financial products and the lies told to the regulators. Money gives the super-rich the power even to rewrite the basic rules of the game by – let’s not mince our words – legally and illegally buying up politicians and political offices

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The trouble is that this process is not instantaneous. It takes time for people to search for new jobs and for companies to find the right people. The result is that some people end up spending some time unemployed in the process. This is known as frictional unemployment.

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Then there is unemployment due to the mismatch between the types of workers demanded and the available workers. This is usually known as technological unemployment or structural unemployment.

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In that it is due to the interferences of ‘political’ entities like the government or trade unions, this type of unemployment may be called political unemployment. The solution offered is to make the labour market more ‘flexible’ through measures like the reduction in trade union power, the abolition of minimum wages and the minimization of worker protection against dismissal.

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It is on the basis of this reasoning that Marx called the unemployed workers the reserve army of labour, who can be called upon any time if the hired workers become too unwieldy.

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is on this ground that Michal Kalecki (1899–1970), the Polish economist who invented Keynes’s theory of effective demand before Keynes, argued that full employment is incompatible with capitalism. We might call this form of unemployment systemic unemployment.

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In order to be classified as unemployed, the person should have been ‘actively seeking work’, which is defined as having applied for paid jobs in the recent past – usually in the preceding four weeks. When you subtract those who are not actively seeking work from your working-age population, you get the economically active population. Only those who are economically active (that is, actively seeking paid jobs) but are not working are counted as unemployed.

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In its purest form, this philosophical stance leads to the view that the government is a product of a social contract between sovereign individuals and thus cannot be above individuals. In this view, known as contractarianism, a state action can be justified only when every individual gives his/her consent.

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More controversially, many economists talk of market failure when there is monopoly or oligopoly – states of affairs collectively known as imperfect competition in Neoclassical economics.

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However, according to Neoclassical economics, it is not the transfer of extra profit from consumers to the firms with market power that is considered to be a market failure. The failure is due to the social loss that even the firms with market power cannot appropriate – known as allocative deadweight loss.

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The common point in all these theories is that the government is controlled and influenced by individuals who are like all other individuals – they are selfish. It is naive, if not exactly delusional, to expect them to put public interests before their own.

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Markets run according to the ‘one-dollar-one-vote’ rule, while democratic politics run on the principle of ‘one-person-one-vote’. Thus, the proposal for greater depoliticization of the economy in a democracy is in the end an anti-democratic project that wants to give more power in the running of the society to those with more money.

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His view of trade is known as the theory of absolute advantage; the idea that a country does not need to trade with another if it can produce everything more cheaply than can its potential trading partner. Indeed – our common sense tells us – why should it?

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Once poor people are persuaded that their poverty is their own fault, that whoever has made a lot of money must deserve it and that they too could become rich if they tried hard enough, life becomes easier for the rich. The poor, often against their own interests, begin to demand fewer redistributive taxes, less welfare spending, less regulation on business and fewer worker rights.

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Individualist economic theories assume individuals to be rational – that is, they know all possible states of the world in the future, make complicated calculations about the likelihood of each of these states and exactly know their preferences over them, thereby choosing the best possible course of action on each and every decision occasion. Once again, the implication is that we should let people be, because ‘they know what they are doing’.

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The problem is, simply put, that human beings are not very rational – or that they possess only bounded rationality.

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Our decisions are heavily affected by the ‘framing’ of the question when they shouldn’t, in the sense that we may make different decisions about essentially the same problem, depending on the way it is presented. And we tend to over-react to new information and under-react to existing information; this is frequently observed in the financial market.

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Above all, we are over-confident about our own rationality.

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In calculating GDP, we measure output – or product – by value added. Value added is the value of a producer’s output minus the intermediate inputs it has used. A bakery may earn £150,000 a year by selling bread and pastries, but if it has paid £100,000 in order to buy various intermediate inputs – raw materials (e.g., flour, butter, eggs, sugar), fuel, electricity and so on – it has only added £50,000 of value to those inputs.

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Then how about D in GDP? ‘Domestic’ here means being within the boundary of a country.

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The number that measures all the output produced by your nationals (including companies), rather than the output produced within your border, is called Gross National Product, or GNP.

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GDP is more frequently used than GNP, since, in the short run, it is the more accurate indicator of the level of productive activities within a country. But GNP is a better measure of an economy’s long-term strength.

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A critical limitation of GDP and GNP measures is that they value outputs at market prices. Since a lot of economic activities occur outside the market, the values of their outputs need to be somehow calculated – ‘imputed’ is the technical word.

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Worse, there is a particular class of non-marketed output whose value isn’t even imputed. Household work – including cooking, cleaning, care work for children and elderly relatives and so on – is simply not counted as part of GDP or GNP. The classic ‘joke’ among economists is that you reduce your national output if you marry your housekeeper.

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The thirty-five low-income countries according to the World Bank classification (countries with less than $1,005 per capita GDP in 2010) collectively had a GDP of$ 0.42 trillion. This is 0.66 per cent of the world economy or 2.9 per cent of the US economy.

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The sum of these incomes is known as Gross Domestic Income, or GDI. In theory, GDI should be identical to GDP, as it is simply a different way of adding up the same thing. But in practice it is slightly different, as some of the data used in compiling the two of them may be collected through different channels.

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Like GNP is to GDP, Gross National Income, or GNI, is to GDI. GNI is the result of adding up the incomes of a country’s citizens, rather than the incomes of those who are producing within its border, which gives us GDI.

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Per capita income, usually measured by GNI (or its product equivalent, GNP) per capita, is considered by many people to be the single best measure of a country’s living standard.

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To use a more technical term, you would say that the average income is a more accurate indicator of the living standard for a country with a more equal distribution of income.

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So, if we exclude countries with a population of less than half a million, Norway, with a per capita income of $85,380, is the richest country (that is, it has the highest per capita GNI).

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Many people question whether happiness can be, and indeed should be, measured at all. The fact that happiness may be conceptually a better measure than income does not mean that we should try to measure it. Richard Layard, the British economist who is a leading scholar trying to measure happiness, defends such attempts by saying, ‘If you think something matters you should try to measure it [italics added].’3 But other people disagree – including Albert Einstein, who once famously said, ‘Not everything that counts can be measured. Not everything that can be measured counts.’

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These people think they are happy because they have come to accept – ‘internalize’ is the fancy word here – the values of the oppressors/discriminators. Marxists call these cases of false consciousness.

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Concluding Remarks: Why Numbers in Economics Can Never Be Objective Defining and measuring concepts in economics cannot be objective in the way such exercises in physics or chemistry can be. Even such an exercise regarding what are seemingly the most straightforward of economic concepts, such as output and income, is fraught with difficulties. A lot of value judgements are involved – for example, the decision not to include household work in output statistics.

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There are many technical problems – especially in relation to the imputation of value to non-marketed activities and to the PPP adjustments. In the case of the poorer countries, there are also issues with data quality – collecting and processing the raw data require financial and human resources that these countries do not have.

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The difference in size is one reason – it is possible to ignore very small countries, even if they are doing very well. But most people do not take Equatorial Guinea’s phenomenal income growth seriously mainly because it is due to a resource bonanza. Nothing about the country’s economy changed other than finding a very large oil reserve in 1996. Without oil, the country would be reduced to one of the poorest in the world once again, which it used to be, as it cannot produce much else.

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But I define it as a process of economic growth that is based on the increase in an economy’s productive capabilities: its capabilities to organize – and, more importantly, transform – its production activities.

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More importantly, countries with superior productive capabilities can even develop substitutes for natural resources, vastly reducing the incomes of countries that rely on exporting them. After Germany and Britain developed technologies to synthesize natural chemicals in the mid-nineteenth century, some countries saw dramatic falls in their incomes.

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Today, technological developments are the result of organized, collective efforts inside and outside productive enterprises, rather than of individual inspiration. The fact that few new technologies these days have their inventors’ names attached to them is a testimony to the collectivization of the innovation process.

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lot of them are due to improvements in organizational skills – or, if you like, management techniques.

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Combining the moving assembly line with the Taylorist principle, the mass production system was born in the early years of the twentieth century. It is often called Fordism because it was first perfected – but not ‘invented’, as the folklore goes – by Henry Ford in his Model-T car factory in 1908. The idea is that production costs can be cut by producing a large volume of standardized products, using standardized parts, dedicated machinery and a moving assembly line. This would also make workers more easily replaceable and thus easier to control, because, performing standardized tasks, they need to have relatively few skills.

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The system, most famously practised by Toyota, has its parts delivered ‘just in time’ for the production, eliminating inventory costs. By working with the suppliers to raise the quality of the parts they deliver (the so-called ‘zero defect movement’), it vastly reduces the need for rework and fine-tuning at the end of the assembly line which had plagued Fordist factories. It also uses machines that allow quick change-overs between different models (e.g., by allowing a quick exchange of dies) and thus can offer a much greater variety of products than the Fordist system does.

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Important as they are, improved technologies and better organizational skills at the firm level are not the only things that determine an economy’s productive capabilities.

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An economy’s productive capabilities also include capabilities that non-enterprise actors – such as the government, universities, research institutes or training institutes – have in facilitating production and improving productivity. These they do by supplying productive inputs: infrastructure (e.g., roads, fibre optic network), new technological ideas and skilled workers.

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If you are monitoring a single economy’s growth performance over a relatively short period of time, say several quarters or a few years, it may not be critical that you are using overall, rather than per capita, growth rate. But, if you are comparing different economies over a relatively long period of time, it is important that you use per capita growth rates.

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The growth rates we use are compound rates (or exponential rates),

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It is useful to have a rule of thumb that enables you to project the future on the basis of today’s growth rate. If you have a growth rate of a country and want to know how much time it will take for the size of its economy to double, divide seventy by the growth rate.

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Share of investment in GDP is the key indicator of how a country is developing

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Nevertheless, the investment ratio – and its evolution over time – is the best single indicator of how a country is developing its productive capabilities and thus its economy.

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Another simple but instructive indicator of a country’s economic development, especially for countries at higher levels of income, is its R&D spending as a ratio of GDP – and its evolution over time.

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Agricultural productivity is very dependent on the physical environment, such as land mass, climate and soil. It is also very time-bound. Impressive ways to overcome all these natural constraints have been developed, such as irrigation, selective breeding and even genetic engineering, but there is a clear limit to them.

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By their very nature, many service activities are inherently impervious to increases in productivity. In some cases, the very increase in productivity will destroy the product itself; a string quartet cannot treble its productivity by trotting through a twenty-seven-minute piece in nine minutes.

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The manufacturing sector has been the ‘learning centre’ of capitalism. By supplying capital goods (e.g., machines, transport equipment), it has spread higher productive capabilities to other sectors of the economy, whether they are other manufacturing activities producing consumer goods (e.g., washing machines, breakfast cereals), agriculture or services.

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It has recently become fashionable to argue that the manufacturing sector does not matter very much any more, as we have entered the era of post-industrial society.

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This prompted the talk of a post-industrial society. Many economists have argued that, with rising income, we begin to demand services, such as eating out and foreign holidays, relatively more than we demand manufactured goods. The resulting fall in the relative demand for manufacturing leads to a shrinking role for manufacturing, reflected in lower output and employment shares.

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Most rich countries have indeed become ‘post-industrial’ or ‘deindustrialized’ in terms of employment; a decreasing proportion of the labour force in these countries is working in factories, as opposed to shops and offices. In most, although not all, countries this has been accompanied by a fall in the share of manufacturing in output. But this does not necessarily mean that those countries are producing fewer manufactured goods in absolute terms. Much of this apparent fall is due to the decline in the prices of manufactured goods, compared to the prices of services.

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The view that the world has now entered a new era of the ‘knowledge economy’, in which making things does not confer much value, is based upon a fundamental misreading of history. We have always lived in a knowledge economy. It has always been the quality of knowledge involved, rather than the physical nature of the things produced (that is, whether they are physical goods or intangible services), that has made the more industrialized countries richer.

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In this regard, it is useful to remember that ‘There are no condemned sectors; there are only outmoded technologies,’ as a French minister of industry once eloquently put

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Today, agriculture plays a very small role, in terms of both output and employment, in the rich countries. Only 1–2 per cent of their GDP is produced in agriculture, while only 2–3 per cent of people work there. This has been possible because agricultural productivity in those countries has risen enormously in the last century or so.

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This suggests that the UK’s deindustrialization has largely been the result of the absolute decline of its manufacturing industry due to loss of competitiveness, rather than the relative price effect due to differential

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An important exception is the UK, in which the share of manufacturing has fallen dramatically in the last couple of decades, even in constant prices.14 This suggests that the UK’s deindustrialization has largely been the result of the absolute decline of its manufacturing industry due to loss of competitiveness, rather than the relative price effect due to differential productivity growth rates.

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largely the result of neo-liberal economic policies implemented in these countries since the 1980s (see Chapter 3).16 Sudden trade liberalization has destroyed swathes of manufacturing industries in those countries. Financial liberalization has allowed banks to redirect their loans to (more lucrative) consumers, away from producers. Policies geared towards inflation control, such as high interest rates and over-valued currencies, have added to the agony of manufacturing firms by making loans expensive and exports more difficult.

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Technology does not only give us access to formerly inaccessible resources but it expands the definition of what is a resource. Sea wave, formerly only a destructive force to be overcome,

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Technology does not only give us access to formerly inaccessible resources but it expands the definition of what is a resource. Sea wave, formerly only a destructive force to be overcome, has become a major energy resource, thanks to technological development.

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Increase in the consumption of collective services, especially public transport and leisure facilities, can improve welfare by reducing the resources wasted in fragmented individualistic consumption: time wasted in sitting in a car in a traffic jam or duplication of services between small private libraries that are popular in countries like Korea.

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Production has been seriously neglected in the mainstream of economics, which is dominated by the Neoclassical school. For most economists, economics ends at the factory gate (or increasingly the entrance of an office block), so to speak. The production process is treated as a predictable process, pre-determined by a ‘production function’, clearly specifying the amounts of capital and labour that need to be combined in order to produce a particular product.

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Unfortunately, with the rise of the discourse of post-industrial society in the realm of ideas and the increasing dominance of the financial sector in the real world, indifference to manufacturing has positively turned into contempt. Manufacturing, it is often argued, is, in the new ‘knowledge economy’, a low-grade activity that only low-wage developing countries do.

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And the scene is by far the best summary of what banking is about: confidence.

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The banks’ ability to create new money (that is, credit) is bought exactly at the cost of instability – that is, the risk of having runs. But the added difficulty is that, once there is a run on some banks, there could be a contagion across all the banks.

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However, this ‘trick’ works only insofar as the confidence problem is one of cash flows – or what is called a liquidity crisis. In this situation, the bank in trouble owns assets (loans that it has made, bonds and other financial assets it has bought, etc.) whose values are greater than its liabilities (deposits, bonds it has issued, loans from another bank, etc.) but it cannot immediately sell those assets and meet all liabilities that are due.

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If the bank has a solvency crisis, which means that the total value of its liabilities exceeds that of its assets, no amount of central bank lending will fix the problem. Either the bank will go bankrupt or require a government bail-out, which happens when the government injects new capital into the troubled bank (as happened with Northern Rock and Icesave). Government bail-out of banks has become highly visible after the 2008 crisis, but it is a practice that has been going on throughout the history of capitalism.

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Another way to manage confidence in the banking system is to restrict the ability of the banks to take risk. This is known as prudential regulation. One important measure of prudential regulation is the ‘capital adequacy ratio’. This limits the amount that a bank can lend (and thus the liabilities it can create in the form of deposits) to a certain multiple of its equity capital (that is, the money provided by the bank’s owners, or shareholders). Such regulation is also known as ‘leverage regulation’, as it is a regulation on how much you can ‘leverage’ your original capital. Another typical measure of prudential regulation is ‘liquidity regulation’, that is, to demand that each bank holds more than a certain proportion of its assets in cash or other highly ‘liquid’ assets (assets that can be quickly sold for cash, such as government bonds).

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Another important function of it – actually the more important function in some countries, such as the US and the UK – is to allow companies to be bought and sold; the market for corporate control is the fancy term. If a new shareholder (or a group of shareholders working together) gains the majority of shares of a company, she (or the group) will become its new owner(s) and dictate its future. This is known as an acquisition or takeover

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The New York Stock Exchange (NYSE) (founded in 1817), the London Stock Exchange (LSX) (founded in 1801) and the Tokyo Stock Exchange (TSE) (founded in 1878) have been the largest stock markets during much of the post-Second World War period. The NASDAQ (National Association of Securities Dealers Automated Quotation), another US stock exchange founded as a ‘virtual’ market in 1971 (it did not have a physical marketplace, like the NYSE, in the beginning), has grown rapidly since the 1980s, thanks to the fact that many fast-growing information technology firms were ‘listed’ there.

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The NYSE price movements are captured by the S&P 500 (compiled by Standard and Poor, the credit rating agency), the LSX ones by FTSE 100 (compiled by the Financial Times) and the TSE ones by Nikkei 225 (compiled by the Nihon Keizai Shimbun, or Japan Economic Times).

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Within this broad framework, there were important international variations. In the US and the UK, these (stock and bond) ‘markets’ were bigger (in relative terms) and more influential than in countries like Germany, Japan or France, where banks played a much more important role. For this reason, the former countries were known to have ‘market-based’ financial systems and the latter ‘bank-based’ ones. The former system is said to generate greater pressure for short-term profits on the part of enterprises than the latter, as shareholders (and bondholders) have less commitment to the companies they ‘own’ than banks do to the companies they lend to.

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In the US, due to the Glass-Steagall Act, the combination of investment banking and commercial banking in a single entity was not allowed between 1933 and 1999.

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Securitized debt products are created by pooling individual loans into a composite bond

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In this way, illiquid assets that cannot easily be sold (such as a mortgage for one particular house, a loan for a particular car) are turned into something (a composite bond) that can be easily traded. Until the rise of ABSs, bonds could be issued only by governments and by very large companies. Now, anything – down to a humble student loan – could be behind a bond.

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But, from the early 1990s, ABSs made of other loans came on stream in the US and then gradually took off in other rich countries, as they abolished regulations that restricted the ability of lending banks to sell off their loans to a third party.

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since ABSs have become ‘structured’ and been turned into Collateralized Debt Obligations (or CDOs). Structuring in this context involves combining a number of ABSs, such as RMBSs, into yet another composite bond, such as CDO, and dividing the new bond into a few tranches (slices) with differential risks. The most ‘senior’ tranche would be made safer by, say, the guarantee that its owners will be asked to bear losses the last (that is, only after the owners of all other, more ‘junior’, tranches have absorbed their losses), should any loss occur. In this way, a very safe financial product could be created out of a pool of relatively unsafe assets – that was at least the theory.

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derivative product called a credit default swap (CDS) was created to supposedly protect you from default on the CDOs by acting as an insurance policy against the risk of default of particular CDOs

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Pooling and structuring simply shift and obscure risk, not eliminate it All of this was deemed to have reduced risk for the financial products concerned – first through safety in numbers (pooling), and then through the deliberate creation of safety zones within that pool (structuring).

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Pooling and structuring simply shift and obscure risk, not eliminate it All

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Derivatives are essentially bets on how ‘other things’ are going to unfold over time2 In addition to the ‘pooled’ and ‘structured’ financial products, investment banks have played a key role in generating and trading derivative financial products, or simply derivatives, in the last three decades.

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Derivatives are essentially bets on how ‘other things’ are going to unfold over

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A classic example is a rice farmer and a rice merchant going into a contract specifying that the farmer will sell his rice to the merchant at a pre-agreed price when he harvests his rice. This type of contract is known as a forward contract, or simply a forward.

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This hedging, or protective, function is, however, not the only – or these days not even the main – function of derivatives. They also allow people to speculate (that is, bet) on the movements of oil prices. In other words, someone who has no inherent interest in the price of oil itself, whether as a consumer or as an oil refinery, can make a bet on the movements of oil prices. Thus, in a provocative but insightful analogy, Brett Scott, a financial activist, points out that ‘[saying] that derivatives exist to allow people to hedge themselves … [is] a bit like arguing that the horse betting industry exists to help horse owners protect themselves from risk [of their horses losing a race].’

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An option contract would give a contracting party the right (but not the obligation) to buy (or sell) something at a price fixed now at some particular date. The option to buy is called a ‘call’ option, and the option to sell is called a ‘put’ option. Options have become more widely known through ‘stock options’ – that is, the right to buy a certain number of stocks (shares) at a pre-agreed price at some future date – given to top managers (and sometimes other employees), to encourage them to manage companies in a way that raises share prices.

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Where a forward is like a bet on a single future event, a swap is like a bet on a series of future events; it is like a number of forward contracts linked together. For example, it allows you to replace a series of variable future payments or earnings with a series of fixed payments or earnings, like contracts for your mobile phone or fixed-price electricity deals over a period, according to Scott’s instructive analogy.

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Then a historic change came in 1982. In that year, two key US financial regulatory bodies, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) agreed that the settlement of a derivative contract does not have to involve the delivery of the underlying goods (e.g., rice or oil) but can be settled in cash.

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Complicated mathematical models were developed to deal with this information overload, but in the end events have proved them to be, at best, woefully inadequate and, at worst, sources of a false sense of control. According to these models, the chances of what happened in 2008 actually happening were equivalent to winning the lottery twenty-one or twenty-two times in a row.

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In this alliance, astronomical salaries were paid to managers in return for maximizing short-term profits – even at the cost of product quality and worker morale – and distributing the biggest possible proportions of those profits to the shareholders, in the form of dividends and share buy-backs (companies buying up their own shares in order to prop up the share price).

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A lot of regulators, who are former employees of the financial sector, are instinctively sympathetic to the industry that they are trying to regulate – this is known as the problem of the ‘revolving door’.

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According to a widely cited study,17 virtually no country was in banking crisis between the end of the Second World War and the mid-1970s, when the financial sector was heavily regulated.

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The rise of the ‘shareholder value maximization’ model in the era of new finance has dramatically reduced the resources available for long-term investments in non-financial corporations.

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Contrary to the popular perception, it is not the issuing of new shares or bank loans but retained profits (that is, profits not distributed to shareholders) that is the main source of investment financing.

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Concluding Remarks: Finance Needs to Be Strictly Regulated Exactly Because It Is So Powerful

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but there is one clear principle that needs to be borne in mind in thinking about the reform. It is that our financial system needs to be made simpler.

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We need to reduce this complexity by limiting the proliferation of overly complicated financial products, especially when their creators cannot prove beyond reasonable doubt that their benefits outweigh their costs.

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The pursuit of equality is a very natural human emotion and has been a powerful driver of human history. Equality was one of the ideals behind the French Revolution, one of whose most famous mottos was ‘Liberté, égalité, fraternité ou la mort’ (liberty, equality, brotherhood or death).

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The advocates of free-market policies, however, warn us against letting such a base instinct take over.

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They tell us not to pull down people higher up just so that we can all be equal. Inequality is an inevitable outcome of different productivities of different people. Rich people are rich because they are better at creating wealth. Trying to go against this natural outcome, we will only create equality in poverty, they warn us.

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Milton Friedman, the guru of free-market economics, meant when he said: ‘Most economic fallacies derive from … the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.’

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Stagnant wages made people incur high levels of debts to keep up with the ever-rising consumption standard at the top. The increase in household debts (as a proportion of GDP) made the economy more vulnerable to shocks.

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Expensive education that only a tiny minority can afford but that you need in order to get a well-paid job, personal connections within a small privileged group (the French sociologist Pierre Bourdieu famously called it social capital)

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What made things worse was that the low degrees of income inequality were often seen as charades. Low income inequality in these countries co-existed with high inequality in other dimensions (e.g., access to higher-quality foreign goods, opportunities to travel abroad), based upon ideological conformity or even personal networks.

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Simon Kuznets, the Russian-born American economist, who won one of the first Nobel Prizes in Economics (in 1971 – the first one was in 1969), proposed a famous theory about inequality over time. The so-called Kuznets hypothesis is that, as a country develops economically, inequality first increases and then decreases.

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According to Kuznets, in the earliest stage of economic development income distribution remains quite equal. It is because most people are poor farmers at that stage. As the country industrializes and grows, more and more people move out of agriculture and into industry, where wages are higher. This increases inequality. As the economy develops even further, Kuznets argued, inequality begins to decrease. Most people now work in the industrial sector or in the urban service sector that serves the industrial sector, while few remain in the agricultural sector with low wages. The result is the famous inverted-U-shaped curve, known as the Kuznets curve,

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Indeed, Kuznets himself did not believe that the decrease in inequality in the later stage of economic development would be automatic. While believing that the nature of modern economic development made the inverted-U curve likely, he emphasized that the actual degree of the decrease in inequality would be strongly affected by the strengths of trade unions and, in particular, of the welfare state.

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The most commonly used measure is known as the Gini coefficient, named after the early twentieth-century Italian statistician Corrado Gini.

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This is known as the global Gini coefficient and calculated by treating each individual in the world as if they are the citizens of the same country.

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We actually don’t really care that much how well people who do not belong to our own reference groups are doing.

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In theory, the Gini coefficient can be anything between 0 and 1. In practice, these extreme values are impossible. No society, however egalitarian it may be in spirit and policies, can make everyone exactly equal, which is what is needed for a Gini coefficient of 0. In a society with a Gini of 1, everyone except one person who has everything will soon be dead.* In real life, no country has a Gini coefficient below 0.2 and none has one above 0.75.

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As mentioned above, before taxes and social spending, some of them are more unequal than the US but they tax and redistribute such a large part of their GDPs that they end up being much more equal than the US.

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Roughly speaking, Gini of 0.35 is the dividing line between relatively equal countries and ones that are not.

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Economists call this kind of poverty absolute poverty. It is the failure to be in command over income to fulfil the most basic human needs for survival – such as nutrition, clothing and shelter. This human condition started to change only in the nineteenth century, with the Industrial Revolution.

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what is known as multidimensional poverty. This is to reflect the fact that some people may have – just – enough income to eat sufficiently and clothe themselves but may have no or little access to things like education and health care. There is no agreement on what should be included in this measure, but this measure naturally increases the number of people living in poverty.

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Attempts to suppress the effects of individual talents and efforts too much, as in the former socialist countries, can create societies that are ostensibly equal but fundamentally unfair, as I discussed above. There are, however, causes of poverty that are ‘structural’ in the sense that they are beyond

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Inadequate childhood nutrition, lack of learning stimulus and sub-par schools (frequently found in poor neighbourhoods) restrict the development of poor children, diminishing their future prospects. Parents may have some control over how much nutrition and learning stimulus their children get – and some poor parents, to their credit, make great efforts and provide more of those things than do other parents in similar situations – but there is a limit to what they can do.

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Despite its overwhelming presence in our lives, work is a relatively minor subject in economics. The only major mention of work is, somewhat curiously, in terms of its absence – unemployment.

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In the dominant Neoclassical view, we put up with the disutility from work only because we can derive utility from things we can buy with the resulting income.

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But can we really call choices made under such circumstances ‘free’? Aren’t these people acting under compulsion – of having to eat?

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left-wing Catholic ‘liberation theology’ especially popular in Latin America between the 1950s and the 1970s, said: ‘When I give food to the poor, they call me a saint. When I ask why the poor have no food, they call me a Communist.’ Perhaps we should all be a bit of a ‘Communist’ and question whether the underlying conditions that make the poor so desperate to voluntarily sign up for ‘bad’ jobs are acceptable.*

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These examples show that poverty is not an excuse for the prevalence of child labour, although it may limit the extent to, and the speed at, which you can reduce it.

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In developing countries, many people are in disguised unemployment in the sense that they have a job that adds very little, if anything at all, to output and mainly acts as a way to get some income. Examples include rural people working on an overcrowded family farm and those poor people in the informal sector (the collection of unregistered small – often one-person – businesses) ‘inventing’ jobs so that they can beg without appearing to beg (more on these later). These people ‘cannot afford to be unemployed’, as the saying goes.

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Another explanation for the faulty stereotypes is that people often mistakenly believe that poverty is the result of laziness and thus automatically assume that people in poorer countries are lazier.7 But what makes those people poor is their low productivity, which is rarely their own fault. What is most important in determining national productivity is the capital equipment, technologies, infrastructure and institutions that a country has,

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So, if anyone is to blame, it is the rich and the powerful in countries such as Greece and Mexico, who have control over those determinants of productivity but have done a poor job in delivering them in sufficient quantity and quality.

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First of all, there is unemployment that happens ‘naturally’. Jobs appear and disappear as companies are born, grow, shrink and die. Workers decide to change their jobs for various reasons; they may have grown dissatisfied with their current job or they decide to move to another town,

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The main solution to cyclical unemployment is to boost demand through government deficit spending and loose monetary policy (such as the lowering of interest rates) until the private sector recovers and starts creating enough new jobs.

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While the Keynesians see unemployment as a cyclical thing, many economists – from Karl Marx to Joseph Stiglitz (in his ‘efficiency wage’ model) – have argued that unemployment is something that is inherent to capitalism.

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So we consider only the working-age population when we calculate unemployment. All countries exclude children from the working-age population, but the definition of children differs across countries; fifteen is the most frequently used threshold, but it could be as low as five (India and Nepal).

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In the poorer developing countries even a lot of children work. In those countries, people are so desperate that they often ‘invent’ jobs in order to survive.

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Despite all this, in most economic discussions, people are mainly conceptualized as consumers, rather than workers. Especially in the dominant Neoclassical economic theory, we are seen as working ultimately to consume.

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Work is seen as an inconvenience that we have to endure in order to get income, and we are seen as being purely driven by our desire to consume with that income. Especially in the rich countries, such consumerist mentality has led to waste, shopping addiction and unsustainable household debts, while making it more difficult to reduce carbon emission and fight climate change.

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High unemployment is considered a relatively minor problem despite its enormous human costs, while a slight rise in inflation is treated as if it is a national disaster.

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The same goes for the old name of economics – political economy, or the study of political management of the economy.

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At one end of the spectrum, we have the free-market view, which wants no more than the minimal state that provides military defence, protection of property rights and infrastructure (like roads and ports).

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At the other end, we have the Marxist view, which believes that markets should be marginalized – or even abolished altogether – and the whole economy coordinated through central planning by the state.

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Most economists these days believe in individualism, namely, the view that there can be no higher authority than individuals.

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In his famous 1651 book, Leviathan, named after the biblical sea monster, Hobbes starts by presuming a ‘state of nature’, in which free individuals existed without a government. In that world, Hobbes argued, individuals were engaged in what he called the ‘war of all against all’, and as a result their lives were ‘solitary, poor, nasty, brutish, and short’. In order to overcome this state of affairs, individuals voluntarily agreed to accept certain restrictions on their freedom imposed by a government so that they could have social peace.

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In this pro-free-market version of contractarianism, more commonly known as libertarianism in the US, Leviathan came to depict the state as a potential monster that needs to be restrained (which is not what Hobbes intended). This view is best summed up in Ronald Reagan’s comment that ‘Government exists to protect us from each other. Where government has gone beyond its limits is in deciding to protect us from ourselves.’

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Asserting that the state is not above its citizens is a very important defence of individuals against the abuse of power by the state, or, rather, by those who control the state machinery.

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The very idea of the free-standing individual is a product of capitalism, which emerged well after the state.

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Thus seen, by basing their theory on a fictitious history, the contractarians have vastly exaggerated individuals’ independence from society and underestimated the legitimacy of collective entities, especially (but not exclusively) the state.

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However, there are some goods whose use by non-payers cannot be prevented, once they are supplied. Such goods (and services) are known as public goods. The existence of public goods is arguably the most frequently cited type of market failure, even more than externality, the original market failure.

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In other words, if you can free-ride on other people to pay for a public good, you don’t have the incentive to voluntarily pay for it. But if everyone thinks the same way, no one will pay for it, which means that the good is not going to be provided at all. At most, it may be provided in sub-optimal quantities by large consumers who would rather let some people free-ride on them than not have the good at all.

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It is therefore widely accepted that public goods can be supplied in optimal quantities only if the government taxes all potential users (which often means all citizens and residents) and uses the proceeds either to provide them itself or to pay some supplier to provide them.

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The case of natural monopoly – which is found in industries like electricity, water, gas and railways – poses a unique challenge. In these industries, having multiple suppliers each with their own networks of, say, water pipes or railways, increases the production cost so much that monopoly is the most cost-efficient arrangement. In such a case, the government may set up an SOE and run it as if it is not a monopoly.

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have just shown that the same market dominated by a monopoly can be seen as a most successful one by one school of economics (the Schumpeterian school or the Austrian school) and as a case of most abject failure by another (the Neoclassical school).

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According to this argument, known as the government failure argument or sometimes the public choice theory, the costs of government failure are usually higher than those of market failures. Thus, it is usually better to accept a failing market than to have the government intervene and mess things up even more.

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When the intention and the ability of the government are suspect, the government failure argument emphasizes, letting the government intervene in the name of correcting for market failure may actually make things worse. Markets may fail, but governments almost always fail even more, is the conclusion.

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The proposal to depoliticize is anti-democratic

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So politics is creating, shaping and reshaping markets before any transaction can begin.

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Transfer in the form of social spending is much lower in developing countries, so the gap between government expenditure as a proportion of GDP and the share of GDP produced by the government is much smaller in those countries.

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Free-market economists, more specifically the proponents of the government failure argument, have persuaded the rest of the world, including many politicians and bureaucrats themselves, that we cannot trust those who run the government to act in public interests. Therefore, they have told us, the less a government does, the better it is. Even in areas where the government is a ‘necessary evil’, it should be constrained by rigid rules that politicians cannot mess around with.

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As I have shown throughout the book, virtually all economic success stories have been facilitated, if not necessarily orchestrated, by an active state.

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Examples of successful state intervention do not, of course, mean that more government is always better. Real-life governments may not necessarily be the Leviathan of the libertarian discourse, but they are not the modern reincarnation of Plato’s Philosopher King either.

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the British started the Opium War in 1840, in which China was pulped. Victorious Britain forced China into free trade, including of opium, with the Nanjing Treaty in 1842. A century of external invasions, civil war and national humiliation followed.

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All that is needed is that it specializes in something in which its superiority is the greatest. Likewise, even if a country is rubbish at producing everything, it can benefit from trade if it specializes in things which it is least rubbish at. International trade benefits every country involved.

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The most important assumption underlying HOS is that all countries have equal productive capabilities – that is, they can use any technology they want.

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This totally unrealistic assumption rules out a priori the most important form of beneficial protectionism, namely, infant industry protection, whose key role in the historical development of today’s rich countries

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HOS can present such a positive view of trade liberalization because it assumes that all capital and labour are the same (‘homogeneous’ is the technical term) and thus can be readily redeployed in any activity (technically this is known as the assumption of perfect factor mobility).

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When they hear someone criticizing free trade, free-trade economists tend to accuse the critic of being ‘anti-trade’. But criticizing free trade is not to oppose trade.

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By providing a bigger market, it allows producers to produce more cheaply, as producing a larger quantity usually lowers your costs (this is known as economies of scale).

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The argument that international trade is essential should never be conflated with the argument that free trade is the best way to trade internationally.

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The Neoclassical school shifted the focus of economics from production to consumption and exchange. For

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The Neoclassical school shifted the focus of economics from production to consumption and exchange.

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In contrast, in Neoclassical economics, the economic system is essentially envisaged as a web of exchanges, ultimately driven by choices made by ‘sovereign’ consumers.

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In contrast, in Neoclassical economics, the economic system is essentially envisaged as a web of exchanges, ultimately driven by choices made by ‘sovereign’ consumers. There is little discussion of how actual processes of production are organized and changed.

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Despite these differences, the Neoclassical school inherited and developed two central ideas of the Classical school. The first is the idea that economic actors are driven by self-interest but that the competition in the market ensures that their actions collectively produce a socially benign outcome.

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The other is the idea that markets are self-equilibrating. The conclusion is, as in Classical economics, that capitalism – or, rather, the market economy, as the school prefers to call it – is a system that is best left alone, as it has a tendency to revert to the equilibrium.

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Vilfredo Pareto (1848–1923) argued that, if we respect the rights of every sovereign individual, we should consider a social change an improvement only when it makes some people better off without making anyone worse off. There should be no more individual sacrifices in the name of the ‘greater good’. This is known as the Pareto criterion and forms the basis for all judgements on social improvements in Neoclassical economics today.6 In real life, unfortunately, there are few changes that hurt no one; thus the Pareto criterion effectively becomes a recipe to stick to the status quo and let things be – laissez faire. Its adoption thus imparted a huge conservative bias to the Neoclassical school.

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With these modifications, there was no reason for the Neoclassical school to remain committed to free-market policies any more. Indeed, between the 1930s and the 1970s, many Neoclassical economists were not free-market economists. The current state of affairs in which the predominant majority of Neoclassical economists are of free-market leaning is actually due more to the shift in political ideology since the 1980s than to the absence or the poor quality of theories within Neoclassical economics

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the same time, the government failure argument was advanced, to argue that market failure in itself cannot justify government intervention because governments may fail even more than markets do

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if you are clever enough, you can justify any government policy, any corporate strategy, or any individual action with the help of Neoclassical economics.

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Neoclassical economics is too accepting of the status quo. In analysing individual choices, it accepts as given the underlying social structure – the distribution of money and power, if you will.

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Neoclassical economics is too accepting of the status quo. In analysing individual choices, it accepts as given the underlying social structure – the distribution of money and power, if you will. This makes it look at only choices that are possible without fundamental social changes.

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The Neoclassical school’s focus on exchange and consumption makes it neglect the sphere of production, which is a large – and the most important, according to many other schools of economics – part of our economy.

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The Marxist school of economics emerged from the works of Karl Marx, produced between the 1840s and the 1860s, starting with the publication of The Communist Manifesto in 1848 (co-authored with Friedrich Engels (1820–95), his intellectual partner and financial patron) and culminating in the publication of the first volume of Capital in 1867.8 It was further developed in Germany and Austria and then in the Soviet Union in the late nineteenth and the early twentieth centuries.* More recently, it was elaborated in the US and Europe during the 1960s and the 1970s.

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Taking the Classical school’s production-based view of the economy further, the Marxist school argued that ‘production is … the basis of social order’,

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Every society is seen as being built on an economic base, or the mode of production. This base is made up of the forces of production (technologies, machines, human skills) and the relations of production (property rights, employment relationship, division of labour). Upon this base is the superstructure, which comprises culture, politics and other aspects of human life, which in turn affect the way the economy is run.

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the Marxist school saw societies as evolving through a series of historical stages, defined in terms of their mode of production: primitive communism (‘tribal’ societies); antiquarian mode of production (based on slavery, as in Greece and Rome); feudalism (based on landlords commanding semi-slaves, or serfs, tied to their lands); capitalism; communism.* Capitalism is seen as but one stage of human development before we reach the ultimate stage of communism.

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It viewed class conflicts as the central force of history – summarized in the declaration in The Communist Manifesto: ‘The history of hitherto existing society is the history of class struggles.’ Moreover, the school refused to see the working class as a passive entity, as did the Classical school, and accorded it an active role in history.

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Capitalism would be replaced by socialism, in which the central planning authority fully coordinates the activities of all the related enterprises, now collectively owned by all workers.

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Insofar as socialism emerged, it did so in countries like Russia and China, where capitalism was hardly developed, rather than in the most advanced capitalist economies, as Marx had predicted.

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Marx was the first economist to pay attention to the differences between the two key institutions of capitalism – the hierarchical, planned order of the firm and the (formally) free, spontaneous order of the market. He described capitalist firms as islands of rational planning in an anarchic sea of the market.

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Moreover, he foresaw that large-scale enterprises owned by multitudes of shareholders with limited liability – which were called ‘joint stock companies’ in his time – would become the leading actors of capitalism, at a time when most free-market economists were still against the very idea of limited liability.

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Last but not least, Marx was also the first major economist who truly understood the importance of technological innovation in the process of capitalist development, making it the central element in his theory.

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The Developmentalist Tradition One-sentence summary: Backward economies can’t develop if they leave things entirely to the market.

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It is what I call the Developmentalist tradition, which started in the late sixteenth and the early seventeenth centuries – two centuries or so before the Classical school.

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This is because policy-makers, who are interested in solving real-world problems, rather than intellectual purity, started the tradition.

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They pulled together elements from different sources in a pragmatic, eclectic manner, even though some of them have made important original contributions of their own. But the tradition is no less important for that. It is arguably the most important intellectual tradition in economics in terms of its impact on the real world. It is this tradition, rather than the narrow rationalism of Neoclassical economics or the Marxist vision of classless society, that has been behind almost all of the successful economic development experiences in human history, from eighteenth-century Britain, through nineteenth-century America and Germany, down to today’s China.

Page: 109, Location: 1668-1673

belonging to the tradition, economic development is not simply a matter of increasing income, which could happen due to a resource bonanza, such as striking oil or diamonds. It is a matter of acquiring more sophisticated productive capabilities, that is, the abilities to produce by using (and developing new) technologies and organizations.

Page: 110, Location: 1677-1679

However, it argues, these activities do not naturally develop in a backward economy, as they are already conducted by firms in the more advanced economies. In such an economy, unless the government intervenes – with tariffs, subsidies and regulations – to promote such activities, free markets will constantly pull it back to what it is already good at – namely, low-productivity activities, based on natural resources or cheap labour.

Page: 110, Location: 1681-1684

The Developmentalist economists of the seventeenth and eighteenth centuries – known as Mercantilists – are these days typically portrayed as having been solely focused on generating trade surplus, that is, the difference between your exports and imports when the former is larger.

Page: 111, Location: 1692-1694

The critical development came from Alexander Hamilton’s invention of the infant industry argument,

Page: 111, Location: 1698-1699

From the late eighteenth century, shedding the Mercantilist garb and its interest in trade surplus, the Developmentalist tradition became more clearly focused on production. The critical development came from Alexander Hamilton’s invention of the infant industry argument,

Page: 111, Location: 1697-1699

Hamilton’s theory was further developed by the German economist Friedrich List, who is these days often mistakenly known as the father of the infant industry argument.11 Alongside List, in the mid-nineteenth century, the German Historical school emerged and dominated German economics until the mid-twentieth century.

Page: 111, Location: 1699-1703

The most important innovation came from Hirschman, who pointed out that some industries have particularly dense linkages (or connections) with other industries; in other words, they buy from – and sell to – a particularly large number of industries. If the government identified and deliberately promoted these industries (the automobile and the steel industries are common examples), the economy would grow more vigorously than when left to the market.

Page: 112, Location: 1712-1715

Given the human tendency to be seduced by a theory that supposedly explains everything, this has put the tradition in seriously lower esteem in most people’s eyes than more coherent and self-confident schools, such as the Neoclassical school or the Marxist one.

Page: 113, Location: 1722-1724

Not all Neoclassical economists are free-market economists. Nor are all free-market economists Neoclassical. The adherents of the Austrian school are even more ardent supporters of the free market than most followers of the Neoclassical school.

Page: 114, Location: 1734-1736

The Austrian school was started by Carl Menger (1840–1921) in the late nineteenth century. Ludwig von Mises (1881–1973) and Friedrich von Hayek (1899–1992) extended the school’s influence beyond its homeland.

Page: 114, Location: 1736-1738

The Austrian school is these days in the same laissez-faire camp with the free-market wing (today the majority) of the Neoclassical school, producing similar, if somewhat more extreme, policy conclusions. However, methodologically it is very different from the Neoclassical school. The alliance between the two groups is due more to their politics than economics.

Page: 114, Location: 1742-1745

The Austrian school also argues that the world is highly complex and uncertain. As its members pointed out in the Calculation Debate, it is impossible for anyone – even the all-powerful central planning authority of a socialist country that can demand any information it wants from anyone – to acquire all the information needed to run a complex economy. It is only through the spontaneous order of the competitive market that the diverse and ever-changing plans of numerous economic actors, responding to unpredictable and complex shifts of the world, can be reconciled with each other.

Page: 115, Location: 1752-1756

Moreover, the market itself is a constructed (rather than spontaneous) order. It is based on deliberately designed rules and regulations that prohibit certain things, discourage others and encourage still others.

Page: 116, Location: 1768-1770

This point can be more clearly seen when we recall that the boundaries of the market have been repeatedly drawn and redrawn through deliberate political decisions – a fact that the Austrian school fails to, or even refuses to, accept.

Page: 116, Location: 1770-1771

The Austrian position against government intervention is too extreme. Their view is that any government intervention other than the provision of law and order, especially protection of private property, will launch the society on to a slippery slope down to socialism – a view most explicitly advanced in Hayek’s The Road to Serfdom.

Page: 116, Location: 1777-1780

The (Neo-)Schumpeterian School One-sentence summary: Capitalism is a powerful vehicle of economic progress, but it will atrophy, as firms become larger and more bureaucratic.

Page: 117, Location: 1784-1786

Joseph Schumpeter (1883–1950) is not one of the biggest names in the history of economics. But his thoughts were original enough to have a whole school named after him – the Schumpeterian, or neo-Schumpeterian, school.* (Not even Adam Smith has a school named after him.)

Page: 117, Location: 1786-1789

Like the Austrians, Schumpeter worked under the shadow of the Marxist school

Page: 117, Location: 1789-1790

He argued that competition through innovation is ‘as much more effective than [price competition] as a bombardment is in comparison with forcing a door’.

Page: 118, Location: 1803-1804

On this, Schumpeter has proven prescient. He argued that no firm, however entrenched it may look, is safe from these ‘gales of creative destruction’ in the long run. The decline of companies like IBM and General Motors, or the disappearance of Kodak, which at their peaks dominated the world in their respective industries, demonstrates the power of competition through innovation.

Page: 118, Location: 1804-1807

he had failed to see how entrepreneurship was fast becoming a collective endeavour, involving not just the visionary entrepreneur but also many other actors inside and outside the firm.

Page: 119, Location: 1816-1817

He made such an incorrect prediction because he had failed to see how entrepreneurship was fast becoming a collective endeavour, involving not just the visionary entrepreneur but also many other actors inside and outside the firm.

Page: 119, Location: 1815-1817

Much of technological progress in complex modern industries happens through incremental innovations originating from pragmatic attempts to solve problems arising in the production process. This means that even production-line workers are involved in innovation. Indeed, Japanese automobile firms, especially Toyota,

Page: 119, Location: 1817-1820

Having failed to appreciate the role of all these ‘other guys’ in the innovation process, Schumpeter came to the mistaken conclusion that the diminishing room for individual entrepreneurs will make capitalism less dynamic and atrophy.

Page: 119, Location: 1823-1825

Born in the same year as Schumpeter and sharing the honour of having a whole school named after him is John Maynard Keynes (1883–1946). In terms of intellectual influence, there is no comparison between the two. Keynes was arguably the most important economist of the twentieth century.

Page: 120, Location: 1834-1835

He redefined the subject by inventing the field of macroeconomics – the branch of economics that analyses the whole economy as an entity that is different from the sum total of its parts.

Page: 120, Location: 1835-1837

Adam Smith when he said, ‘What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.’

Page: 120, Location: 1837-1838

Rejecting this view, Keynes sought to explain how there could be unemployed workers, idle factories and unsold products for prolonged periods when markets are supposed to equate supply and demand.

Page: 121, Location: 1842-1843

Keynes started from the obvious observation that an economy doesn’t consume all that it produces. The difference – that is, savings – needs to be invested, if everything that has been produced is to be sold and if all productive inputs, including the labour service of workers, are to be employed (this is known as full employment).

Page: 121, Location: 1845-1847

For some things, we can rather accurately calculate the probability of each possible contingency – economists call this risk. Indeed, our ability to calculate the risk involved in many aspects of human life – death, fire, car accident and so on – is the very foundation of the insurance industry.

Page: 121, Location: 1853-1855

In a press briefing regarding the situation in Afghanistan in 2002, Rumsfeld opined: ‘There are known knowns. There are things we know that we know. There are known unknowns. That is to say, there are things that we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know.’ The idea of ‘unknown unknowns’ nicely sums up Keynes’ concept of uncertainty.

Page: 122, Location: 1857-1860

Keynes argued that this does not happen. As investment falls, overall spending falls, which then reduces income, as one person’s spending is another’s income. A reduction in income in turn reduces savings, as savings are essentially what are left after consumption (which tends not to change much in response to a fall in income, being determined by our survival necessities and habit). In the end, savings will contract to match the now lower investment demand. If excess savings are reduced in this way, there will be no downward pressure on interest rates and thus no extra stimulus for investment.

Page: 122, Location: 1865-1869

Keynes thought that investment will be high enough for full employment only when animal spirits – ‘a spontaneous urge to action rather than inaction’, as he defines it – of the potential investors are stimulated by new technologies, financial euphoria and other unusual events. The normal state of affairs, in his view, would be that investment is equated to savings at a level of effective demand (the demand that is actually backed up by purchasing power) that is insufficient to support full employment. In order to achieve full employment, Keynes argued, the government therefore has to use its spending actively to prop up the level of demand.

Page: 122, Location: 1870-1875

The prevalence of uncertainty in Keynesian economics means that money is not simply an accounting unit or merely a convenient medium of exchange, as the Classical (and the Neoclassical) school thought. It is a means to provide liquidity (or the means to quickly change one’s financial position) in an uncertain world.

Page: 123, Location: 1878-1880

In this market, the buying and selling of an asset is driven not mainly by the ultimate return that it will deliver but by expectations about the future – and, more importantly, the expectations about what other people expect, or, as Keynes put it, the ‘average opinion about the average opinion’.

Page: 123, Location: 1882-1885

This, according to Keynes, provides the basis for the herd behaviour that is often witnessed in financial markets,

Page: 123, Location: 1885-1885

It is upon this analysis that Keynes famously warned against the danger that the speculation-driven financial system can pose: ‘Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’

Page: 124, Location: 1887-1891

The Keynesian school can be criticized for paying too much attention to short-term issues – as summarized in the famous quip by Keynes that ‘in the long run we are all dead’.

Page: 125, Location: 1904-1906

The emergence of the Institutionalist school can be traced back to Thorstein Veblen (1857–1929), who made his name for questioning the notion of the rational, self-seeking individual.

Page: 126, Location: 1919-1920

He argued that humans have layers of motivations behind their behaviours – instinct, habit, belief and, only finally, reason.

Page: 126, Location: 1920-1921

The school was officially proclaimed as the Institutionalist school in 1918 with Veblen’s blessing, under the leadership of Wesley Mitchell (1874–1948), Veblen’s student and the then leader of the group.

Page: 126, Location: 1928-1929

The school’s shining moment was the New Deal, in whose design and administration many of its members participated.

Page: 126, Location: 1930-1931

Institutional economists, such as Arthur Burns (chairman of the Council of Economic Advisors to the US President, 1953–6; then chairman of the Federal Reserve Board, 1970–78), played important parts in the making of US economic policy even after the Second World War.

Page: 127, Location: 1936-1938

However, institutions may come into being in other ways: as a spontaneous order emerging out of interactions of rational individuals (the Austrian school and the New Institutionalist Economics); through attempts by individuals and organizations to develop cognitive devices that will allow them to cope with complexity (the Behaviouralist school); or as a result of an attempt to maintain existing power relationships (the Marxist school).

Page: 127, Location: 1945-1948

So, in this broader definition, transaction cost includes the cost of policing against thefts, running the court system and even monitoring workers in factories so that they put in the maximum possible amount of labour service specified in their contract.

Page: 129, Location: 1968-1969

The Behaviouralist school is so called because it tries to model human behaviours as they actually are, rejecting the dominant Neoclassical assumption that human beings always behave in a rational and selfish way.

Page: 130, Location: 1986-1988

Simon’s central concept is bounded rationality. He criticizes the Neoclassical school for assuming that people possess unlimited capabilities to process information, or God-like rationality (he calls it ‘Olympian rationality’).

Page: 131, Location: 1995-1997

Simon did not argue that human beings are irrational. His view was that we try to be rational but that our ability to be so is very limited, especially given the complexity of the world – or given the prevalence of uncertainty, if you want to formulate it in the Keynesian way.

Page: 131, Location: 1997-2000

Given our bounded rationality, Simon argued, we develop mental ‘shortcuts’ that allow us to economize on our mental capabilities. These are known as heuristics (or intuitive thinking) and can take different forms: rule of thumb, common sense or expert judgement. Underlying all these mental devices is the ability to recognize patterns, which allows us to abandon a large range of alternatives and focus on a small, manageable but most promising range of possibilities.

Page: 131, Location: 2001-2004

Focusing on a subset of possibilities means that the resulting choice may not be optimal, but this approach enables us to handle the complexity and the uncertainty of the world with our bounded rationality. Therefore, Simon argues, when they make their choices, human beings satisfice, that is, we look for ‘good enough’ solutions rather than the best ones, as in the Neoclassical theory.

Page: 131, Location: 2007-2010

Herbert Simon, writing in the mid-1990s, reckoned that something like 80 per cent of economic activities in the US happen inside organizations, such as the firm and the government, rather than through the market.26 He argued that it would be more appropriate to call it the organization economy.

Page: 132, Location: 2022-2026

The Behaviouralists argue that organizational loyalty of their members is essential for organizations to operate well, as an organization full of disloyal members would be overwhelmed by the costs of monitoring and punishing their selfish behaviours.

Page: 133, Location: 2032-2034

It also needs to be added that, given its focus on human cognition and psychology, the Behaviouralist school has few things to say about issues of technology and macroeconomics.

Page: 134, Location: 2044-2045

The dominant Neoclassical view is that economics is the ‘science of choice’, as we saw in Chapter 1. According to this position, choices are made by individuals, who are assumed to be selfish, only interested in maximizing their own welfare – or at most that of their family members. In doing so, all individuals are seen to make rational choices, namely, they choose the most cost-efficient way to achieve a given goal.

Page: 139, Location: 2120-2123

Even though this individualist vision is not the only way to theorize our economy (see Chapter 4), it has become the dominant one since the 1980s. One reason is that it has powerful political and moral appeals. It is, above all, a parable of individual freedom.

Page: 140, Location: 2137-2140

Friedrich von Hayek’s seminal critique of socialism, The Road to Serfdom, and Milton Friedman’s passionate advocacy of the free-market system, Free to Choose, are famous examples.

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Adam Smith’s famous passage is the classic statement of this position: ‘It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.’

Page: 141, Location: 2152-2153

They found the individualistic vision to have been obsolete at least since the late nineteenth century. Since then, most important economic actions in our economies have been undertaken not by individuals but by large organizations with complex internal decision-making structures – corporations, governments, trade unions and increasingly even international organizations.

Page: 142, Location: 2167-2170

The 200 largest corporations between themselves produce around 10 per cent of the world’s output. It is estimated that 30–50 per cent of international trade in manufactured goods is actually intra-firm trade, or transfer of inputs and outputs within the same multinational corporation (MNC) or transnational corporation (TNC), with operations in multiple countries.

Page: 142, Location: 2173-2176

The shares that come with the right to vote on those things are called ordinary shares. The ‘ordinary’ shareholders (who are anything but ordinary in terms of decision-making power) make collective decisions through votes. These votes are usually according to the one-share-one-vote rule, but in some countries some shares have more votes than others; in Sweden, some shares could have up to 1,000 votes each.

Page: 143, Location: 2192-2195

Dispersed ownership means that professional managers have effective control over most of the world’s largest companies, despite not owning any significant stake in them – a situation known as the separation of ownership and control. This creates a principal-agent problem, in which the agents (professional managers) may pursue business practices that promote their own interests rather than those of their principals (shareholders). That is, professional managers may maximize sales rather than profit or may inflate the corporate bureaucracy, as their prestige is positively related to the size of the company they manage (usually measured by sales) and the size of their entourage.

Page: 144, Location: 2208-2213

The second is paying large parts of managerial salaries in the form of their own companies’ stocks (stock option), so that they are made to look at things more from the shareholder’s point of view. The idea was summarized in the term shareholder value maximization, coined in 1981 by Jack Welch, the then new CEO and chairman of General Electric, and has since ruled the corporate sector first in the Anglo-American world and increasingly in the rest of the world.

Page: 145, Location: 2219-2223

In addition to trade union activities (which we’ll explore below), workers in some European countries, such as Germany and Sweden, influence what their companies do through formal representation on company boards. In particular in Germany, large companies have a two-tier board structure. Under this system, known as the co-determination system, the ‘managerial board’ (like the board of directors in other countries) has to get the most important decisions, such as merger and plant closure, approved by the ‘supervisor board’, in which worker representatives have half the votes, even though the managerial side appoints the chairman, who has the casting vote.

Page: 146, Location: 2226-2231

Some large companies are cooperatives owned by their users (consumers or savers), employees or independent smaller business units.

Page: 147, Location: 2249-2250

There are two types of producer cooperatives: worker cooperatives, owned by their own employees, and producer cooperatives, owned by independent producers that agree to do certain things together by pooling their resources.

Page: 148, Location: 2258-2260

The most common examples of cooperatives of independent producers selectively working together are dairy farmers’ cooperatives, in which farmers own their cows but together process and sell the milk and milk products (butter, cheese, etc.).

Page: 148, Location: 2266-2268

In modern economies, at least some workers do not make economic decisions as individuals any more. Many workers are organized into trade unions, or labour unions. Allowing workers to bargain as a group, rather than as individuals who may compete against each other, trade unions help workers extract higher wages and better working conditions from their employers.

Page: 149, Location: 2279-2282

In most countries, the government is by far the single largest employer, employing anything up to 25 per cent of the national workforce in some cases.* Its expenditure is equivalent to anything between 10 and 55 per cent of national output, with the ratio generally higher in the richer countries than in the poorer ones.

Page: 151, Location: 2311-2314

Some international organizations are important because – how shall I put it? – they have money. The World Bank and other ‘regional’ multilateral banks, predominantly owned by rich country governments, make loans to developing countries.* When they lend, they offer more favourable terms (lower interest rates, longer repayment periods) than do private-sector banks.

Page: 153, Location: 2336-2339

The International Monetary Fund (IMF) makes large-scale loans on a short-term basis to countries in financial crises, which cannot borrow from the private market.

Page: 153, Location: 2339-2340

Most importantly, the US has de facto veto power in the Bank and the Fund, as the most important decisions in them require an 85 per cent majority, and the US happens to own 18 per cent of shares.

Page: 153, Location: 2345-2346

The WTO sets rules on international economic interactions, including international trade, international investment and even the cross-border protection of intellectual property rights, such as patents and copyrights. It is, importantly, the only international organization that is based on the one-country-one-vote rule.

Page: 154, Location: 2351-2353

This happens because people have multiple roles in their lives – a husband and a foot soldier in the above example. They are expected to, and do, act differently in different roles.

Page: 156, Location: 2378-2379

The multiple-self problem shows that individuals are not atoms because they can be broken down further. They are not atoms also because they are not clearly separable from other individuals.

Page: 156, Location: 2387-2388

They treat them as the ultimate data, generated from within ‘sovereign’ individuals. The idea is best summarized in the maxim ‘De gustibus non est disputandum’ (‘Taste is not a matter of dispute’).

Page: 156, Location: 2389-2391

Margaret Thatcher was seriously wrong when she famously (or infamously) said, ‘There is no such thing as society. There are individual men and women, and there are families.’ There cannot be such a thing as an individual without society.

Page: 157, Location: 2395-2397

All aspects of human life – political propaganda, education, religious teachings, the mass media – involve such manipulation to one degree or another. The most well-known instance is advertising.

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Note: Term

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Note: Imp.

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Note: Imp.

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Note: Term…

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Note: Term…

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Note: Imp…

Positional goods are goods whose values derive from the fact that only a small proportion of potential consumers can have them.

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Note: Term…

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Note: Imp

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Note: Imp

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Note: Imp

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Note: Term

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Note: Term

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Note: Imp

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Note: Imp

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Note: Imp

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Note: Term

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Note: Imp

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Note: Imp

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Note: Imp

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Note: Imp

The rise of the ‘shareholder value maximization’ model in the era of new finance has dramatically reduced the resources available for long-term investments

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Note: Imp

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Note: Imp

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Note: Imp

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Note: Imp

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Note: Term

Then there is unemployment due to the mismatch between the types of workers demanded and the available workers. This is usually known as technological unemployment or structural unemployment.

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Note: Term

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Note: Term

It is on the basis of this reasoning that Marx called the unemployed workers the reserve army of labour, who can be called upon any time if the hired workers become too unwieldy.

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Note: Term

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Note: Term

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Note: Imp

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Note: Term

More controversially, many economists talk of market failure when there is monopoly or oligopoly – states of affairs collectively known as imperfect competition in Neoclassical economics.

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Note: Term

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Note: Term

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Note: Imp

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Note: Imp

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Note: Term

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The problem is, simply put, that human beings are not very rational – or that they possess only bounded rationality.

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Above all, we are over-confident about our own rationality.

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Then how about D in GDP? ‘Domestic’ here means being within the boundary of a country.

Page: 168, Location: 2571-2571

The number that measures all the output produced by your nationals (including companies), rather than the output produced within your border, is called Gross National Product, or GNP.

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Per capita income, usually measured by GNI (or its product equivalent, GNP) per capita, is considered by many people to be the single best measure of a country’s living standard.

Page: 173, Location: 2644-2646

To use a more technical term, you would say that the average income is a more accurate indicator of the living standard for a country with a more equal distribution of income.

Page: 173, Location: 2651-2652

So, if we exclude countries with a population of less than half a million, Norway, with a per capita income of $85,380, is the richest country (that is, it has the highest per capita GNI).

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lot of them are due to improvements in organizational skills – or, if you like, management techniques.

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Important as they are, improved technologies and better organizational skills at the firm level are not the only things that determine an economy’s productive capabilities.

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The growth rates we use are compound rates (or exponential rates),

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Share of investment in GDP is the key indicator of how a country is developing

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Nevertheless, the investment ratio – and its evolution over time – is the best single indicator of how a country is developing its productive capabilities and thus its economy.

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It has recently become fashionable to argue that the manufacturing sector does not matter very much any more, as we have entered the era of post-industrial society.

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In this regard, it is useful to remember that ‘There are no condemned sectors; there are only outmoded technologies,’ as a French minister of industry once eloquently put

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Technology does not only give us access to formerly inaccessible resources but it expands the definition of what is a resource. Sea wave, formerly only a destructive force to be overcome,

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And the scene is by far the best summary of what banking is about: confidence.

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In the US, due to the Glass-Steagall Act, the combination of investment banking and commercial banking in a single entity was not allowed between 1933 and 1999.

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Securitized debt products are created by pooling individual loans into a composite bond

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derivative product called a credit default swap (CDS) was created to supposedly protect you from default on the CDOs by acting as an insurance policy against the risk of default of particular CDOs

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Pooling and structuring simply shift and obscure risk, not eliminate it All

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Derivatives are essentially bets on how ‘other things’ are going to unfold over

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According to a widely cited study,17 virtually no country was in banking crisis between the end of the Second World War and the mid-1970s, when the financial sector was heavily regulated.

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The rise of the ‘shareholder value maximization’ model in the era of new finance has dramatically reduced the resources available for long-term investments in non-financial corporations.

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Concluding Remarks: Finance Needs to Be Strictly Regulated Exactly Because It Is So Powerful

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but there is one clear principle that needs to be borne in mind in thinking about the reform. It is that our financial system needs to be made simpler.

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The advocates of free-market policies, however, warn us against letting such a base instinct take over.

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The most commonly used measure is known as the Gini coefficient, named after the early twentieth-century Italian statistician Corrado Gini.

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This is known as the global Gini coefficient and calculated by treating each individual in the world as if they are the citizens of the same country.

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We actually don’t really care that much how well people who do not belong to our own reference groups are doing.

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Roughly speaking, Gini of 0.35 is the dividing line between relatively equal countries and ones that are not.

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Despite its overwhelming presence in our lives, work is a relatively minor subject in economics. The only major mention of work is, somewhat curiously, in terms of its absence – unemployment.

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In the dominant Neoclassical view, we put up with the disutility from work only because we can derive utility from things we can buy with the resulting income.

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But can we really call choices made under such circumstances ‘free’? Aren’t these people acting under compulsion – of having to eat?

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These examples show that poverty is not an excuse for the prevalence of child labour, although it may limit the extent to, and the speed at, which you can reduce it.

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In the poorer developing countries even a lot of children work. In those countries, people are so desperate that they often ‘invent’ jobs in order to survive.

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High unemployment is considered a relatively minor problem despite its enormous human costs, while a slight rise in inflation is treated as if it is a national disaster.

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The same goes for the old name of economics – political economy, or the study of political management of the economy.

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Most economists these days believe in individualism, namely, the view that there can be no higher authority than individuals.

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Asserting that the state is not above its citizens is a very important defence of individuals against the abuse of power by the state, or, rather, by those who control the state machinery.

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The very idea of the free-standing individual is a product of capitalism, which emerged well after the state.

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The proposal to depoliticize is anti-democratic

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So politics is creating, shaping and reshaping markets before any transaction can begin.

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As I have shown throughout the book, virtually all economic success stories have been facilitated, if not necessarily orchestrated, by an active state.

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The most important assumption underlying HOS is that all countries have equal productive capabilities – that is, they can use any technology they want.

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When they hear someone criticizing free trade, free-trade economists tend to accuse the critic of being ‘anti-trade’. But criticizing free trade is not to oppose trade.

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By providing a bigger market, it allows producers to produce more cheaply, as producing a larger quantity usually lowers your costs (this is known as economies of scale).

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The argument that international trade is essential should never be conflated with the argument that free trade is the best way to trade internationally.

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The Neoclassical school shifted the focus of economics from production to consumption and exchange. For

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The Neoclassical school shifted the focus of economics from production to consumption and exchange.

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In contrast, in Neoclassical economics, the economic system is essentially envisaged as a web of exchanges, ultimately driven by choices made by ‘sovereign’ consumers.

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the same time, the government failure argument was advanced, to argue that market failure in itself cannot justify government intervention because governments may fail even more than markets do

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if you are clever enough, you can justify any government policy, any corporate strategy, or any individual action with the help of Neoclassical economics.

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Neoclassical economics is too accepting of the status quo. In analysing individual choices, it accepts as given the underlying social structure – the distribution of money and power, if you will.

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Taking the Classical school’s production-based view of the economy further, the Marxist school argued that ‘production is … the basis of social order’,

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Capitalism would be replaced by socialism, in which the central planning authority fully coordinates the activities of all the related enterprises, now collectively owned by all workers.

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Insofar as socialism emerged, it did so in countries like Russia and China, where capitalism was hardly developed, rather than in the most advanced capitalist economies, as Marx had predicted.

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The Developmentalist Tradition One-sentence summary: Backward economies can’t develop if they leave things entirely to the market.

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It is what I call the Developmentalist tradition, which started in the late sixteenth and the early seventeenth centuries – two centuries or so before the Classical school.

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This is because policy-makers, who are interested in solving real-world problems, rather than intellectual purity, started the tradition.

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The critical development came from Alexander Hamilton’s invention of the infant industry argument,

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The (Neo-)Schumpeterian School One-sentence summary: Capitalism is a powerful vehicle of economic progress, but it will atrophy, as firms become larger and more bureaucratic.

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Like the Austrians, Schumpeter worked under the shadow of the Marxist school

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He argued that competition through innovation is ‘as much more effective than [price competition] as a bombardment is in comparison with forcing a door’.

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he had failed to see how entrepreneurship was fast becoming a collective endeavour, involving not just the visionary entrepreneur but also many other actors inside and outside the firm.

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He redefined the subject by inventing the field of macroeconomics – the branch of economics that analyses the whole economy as an entity that is different from the sum total of its parts.

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Adam Smith when he said, ‘What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.’

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Rejecting this view, Keynes sought to explain how there could be unemployed workers, idle factories and unsold products for prolonged periods when markets are supposed to equate supply and demand.

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This, according to Keynes, provides the basis for the herd behaviour that is often witnessed in financial markets,

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The Keynesian school can be criticized for paying too much attention to short-term issues – as summarized in the famous quip by Keynes that ‘in the long run we are all dead’.

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The emergence of the Institutionalist school can be traced back to Thorstein Veblen (1857–1929), who made his name for questioning the notion of the rational, self-seeking individual.

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He argued that humans have layers of motivations behind their behaviours – instinct, habit, belief and, only finally, reason.

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The school’s shining moment was the New Deal, in whose design and administration many of its members participated.

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It also needs to be added that, given its focus on human cognition and psychology, the Behaviouralist school has few things to say about issues of technology and macroeconomics.

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Friedrich von Hayek’s seminal critique of socialism, The Road to Serfdom, and Milton Friedman’s passionate advocacy of the free-market system, Free to Choose, are famous examples.

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Some large companies are cooperatives owned by their users (consumers or savers), employees or independent smaller business units.

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The International Monetary Fund (IMF) makes large-scale loans on a short-term basis to countries in financial crises, which cannot borrow from the private market.

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Most importantly, the US has de facto veto power in the Bank and the Fund, as the most important decisions in them require an 85 per cent majority, and the US happens to own 18 per cent of shares.

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This happens because people have multiple roles in their lives – a husband and a foot soldier in the above example. They are expected to, and do, act differently in different roles.

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The multiple-self problem shows that individuals are not atoms because they can be broken down further. They are not atoms also because they are not clearly separable from other individuals.

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All aspects of human life – political propaganda, education, religious teachings, the mass media – involve such manipulation to one degree or another. The most well-known instance is advertising.

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