Economics is not the study of choice

Turns out I actually do have something to write about. A propos of Yglesias and Rodrik, I think people really need to stop thinking about Economics as some sort of study of choice, which is how it is traditionally conceived. Yglesias quotes Rodrik…

The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact, the kind of markets that modern economies need are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance.

…and notes that non-interventionist environments don’t really exist. The market doesn’t appear ex nihilo and it isn’t really helpfully conceived of as a way of aggregating individual choices.

For a long time individual choice involved fighting and then using brute force and intimidation to get what you want. The key innovation of modern states wat to turn brute force and intimidation towards the realm of enforcement of contracts.

I think economics is much better thought of a study of contracts, expectations and choices last. The contractual elements of live take up most of your expenditure, housing, healthcare and saving for retirement and all of those things depend far more on your (and our collective) expectation of the future.

Choice comes into the picture only later on. Rational Choice theory is useful for estimating how people make certain choices, but it is the imposition of brute force strengthening contract enforcement and making the future more predictable that may be better routes for thinking about economics.

For example, Scott Sumner‘s proposal for central banks to adopt NGDP targeting, level targeting. This isn’t economics about choice, this is economics which is intended to make contracts easier to create ex ante and enforce ex post because it is about aligning expectations with what the future will actually be like in a stable way. Contracts and expectations form the core of economics, they are just very complicated in real world and difficult to model in the theoretical.


A Safer Way to Save the Eurozone

Cross published from my Uni paper, not sure if I’m allowed. But hey, I’ve nothing else written.

For the fourth or fifth time in as many years Europe needs a rescue plan. A group of academics from all around Europe, including LSEs Professor Luis Garicano and Professor Dimitri Vayanose now have a proposal which may be part of the last rescue plan necessary.

The problem is simple. Many countries, from Greece to Portugal, Italy, Spain and Ireland, carry debts they may not be able to pay back in full. Failure to pay back these debts would return Europe to recession because much of this debt is held by European banks who once considered it safe.

There is enough money in Europe to pay these countries debts, it is just that it is earned and spent in Germany by Germans, and the Germans are understandably keen to keep it this way. Previous plans have fallen short because the citizens of northern Europe are unwilling to commit to a bailout of southern Europe.

A rescue plan is not elusive because the economics are hard, politics is the fundamental problem. A successful plan to save Europe from renewed crisis will need to leverage Europes economic clout to shore up confidence in its riskier members in a way which does not put German taxpayers money in harm’s way. Eurobonds, once mooted as a potential solution to Europes woes were rejected for just this reason. They would have left Germany and other safe European countries on the line for the risky borrowing of other European countries.

Their rescue plan, published at the Euro-nomics website, is gaining traction with many of institutions at the heart of Europe. They propose to bundle up a portion of the debts of all Eurozone members and split it into a safe senior tranche and a risky junior tranche. Complex financial products got us into this mess and it is hoped that they may well get us out.

The senior tranche of debt would be known as European Safe Bonds (or ESBies, if you like your financial derivatives to have cute names) and would be amongst the safest financial assets in the world. They would be backed by the first 70% of debt payments from all European countries. Were things to go badly wrong through the Eurozone and many countries were to default ESBies would remain safe.

By their calculations, this means ESBies would only suffer losses every 600 years or so. They would be dull and their rewards would be meagre, just what Europe needs in these troubled times. Those who wanted higher returns, hedge fund and private equity investors, could gamble on the junior tranche without the problems caused by risky bonds being held by large banks.

This is important, rescue Europe and you rescue the employment opportunities of everyone who graduates from LSE next year. It would take a few months to get up and running but even moving towards this solution would calm markets and help return Europe and the world to stability.