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Confusion Reigns

What on earth were they doing?

Rocked but undaunted by the great financial crisis the orthodoxy of our central banks survived to fight another day.  The system had been saved.  That no one saw the onrushing crisis is still being debated.  Of course some people saw it coming.  Anyone with a scintilla of understanding of Minsky for instance.  But those folk are hard to find in the top seats of central banks.

The objective of the so-called independent central bank is to preserve the system.  To make it safe for markets to continue undisturbed by the intrusions of political whims.  To save, that is, capitalism from the depraved intrusions of democracy.  The idea is to separate as firmly as possible the political and the economic realms.  After all as economists seem to believe: people are astonishingly rational when they participate as market members, but are hopelessly self-indulgent and irrational when they participate as voters.  We all suffer from split personalities in economic orthodoxy.  Rational one minute, mindlessly mixed up the next.  It’s an interesting view of human behavior.  It undergirds, in rather more formal guise, orthodoxy and its resolute defense of central bank independence.

This independence is supposed to maintain a wall between these two halves of our personalities.  Making the system safe for markets means guarding vigilantly against the inevitable weaknesses of politicians who might fall victim to the democratic urge to look after the majority of voters.  That would be awful.  Inflation would surely surge as money flooded throughout the corrupted economic machinery.  That surge would be inevitable.  Politicians are notorious for acting on incentives.  Like getting re-elected.  That makes them very bad custodians of an economy which must always follow a sober and self-denying path.  Sobriety and self-denial are, as we all know, the hallmarks of solid market activity.  Markets, thus unencumbered by political mischief, can go about their perfect work allocating resources in the most efficient manner possible and distributing the consequent rewards according to the blindingly objective rules that economists have identified as the natural doings of market processes.

So what just happened?  What on earth were they doing?

Central banks the world over, with very few exceptions, have clearly forgotten or buried that sober and self-denying impulse.

They’ve been monetizing the debt.

How horrid.

And not just on a small or limited scale.  They’ve been going all in.  They’re not supposed to do this.  Not at all.

The objective of this heterodox outburst was to save the system.  That’s the same objective, you will note, that previously drove them to deny monetization of debt at all costs.  So what was once apostasy is now good faith.  And what was good faith is apostasy.  It’s hard to keep up.

Does this mean that all those years of relentless near puritanical denial and mean-spirited policy were incorrect?  In a related vein does this mean that unemployment was not always and everywhere voluntary?  Where did this great flip-flop come from?

Was orthodoxy wrong?  Or was it just a special case to be tossed overboard when the system really needed saving and manifestly couldn’t save itself? We have been told for decades that printing money for politically motivated reasons such as bolstering social programs is destabilizing and flat out wrong.  Only a fool would advocate printing tons of money and flooding it into the economy.  As for monitoring the debt: well, that’s beyond the pale.

Until.

Until it isn’t.

So let me get this right.

Printing money for political reasons is just bad.  Printing money to save the system is wonderful.

The ease with which orthodoxy has been bent in order to save the system seems to indicate a certain — how do I say this delicately? — lack of principle.  Surely printing money is printing money.  Monetizing debt is monetizing debt.  In the wonderful world of economics the ends surely don’t justify the means.  I thought economies behaved according to smoothly unfolding laws.  Are the central banks telling us that those laws are simply contextual?  Or, worse, ideologically constructed?

Surely not!

Perhaps, more likely, all economics is contextual.  Circumstances drive what is appropriate.  There are multiple orthodoxies depending on the state of play, history, and the urgencies of the moment.  By and large the central banks have done a decent job steering their respectivpe economies through the disruption of the pandemic.  What they have done is to upend what they held as true previously.  They have demonstrated the relativity of economics.

Now the danger is passing, a great debate is under way: will the central banks revert to what they did before?  Or will they, having broken the old orthodoxy in order to save the system, develop some new orthodoxy?  Old habits die hard.  I think the smart money will be on a convenient forgetting of the efficacy of what was just done.  The banks will revert.  It’s the safe thing to do.

Which raises one last question:  which was out of step with which?  Was it the old orthodoxy that had been made obsolete by developments in the system?  Or was it that the system never really conformed to what the old orthodoxy described?  Had economics stopped being a study of economic activity and become, instead, a design or blueprint for it?  I think the latter.  Having become part of the technocratic milieu of the late twentieth century economics was no longer a study of something.  It was a prescription for something.  The trouble being that the description of capitalism that justified the subsequent prescriptions was not the capitalism found in the real world.  So orthodoxy was always out of step with reality.  It’s just that there was insufficient disruption to show the disjuncture clearly enough.

Now we know.

And so do the central banks.  No wonder confusion reigns.

 

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Domain Shift

Brian Arthur tells us that technology most often advances in the form of domain shifts.  In his narrative technologies cluster in related groups he calls domains.  So individual technologies might advance through a tweak here or there, but the economy advances through a shift from one cluster of technologies to another.

I like this idea.  Especially when we then broaden the topic to use technology as a background against which we view a particular slice of history.  Thus we can think, legitimately about the “steam era” and such.  Adding insight to this, Arthur situates all technologies as extensions of natural phenomena.  So he characterizes a technology as a phenomenon being “captured and put to use”.

All good.  This gives us a practical definition of technology and helps map its evolution onto the changes of society itself as it became more and more infused by technology.

Arthur also tries to make us embrace a very broad notion of technology.  He insists that a great number of social structures can also be defined as technologies.  So a modern business organization is a technology, as is any other institution.  I agree.  When we go further and identify that most, if not all, technologies can be segmented into sub-technologies we start to see commonalities that might elude us in a more holistic analysis.  This does not imply we can predict the higher level organization from the sum of the component parts, but it does allow us to see common ancestors to many of our contemporary technologies: they are rooted in lineages in the same way that the natural world is.

Let’s stay with this.

If a modern business corporation is an instance of a technology and is comprised of sub-technologies drawn from a common domain then we can identify the notion of shareholder value as one such component.  It is a technology.  That it has come to play such a prominent role in the overall construct of the corporation needs explanation.  How come other components didn’t reach the same dominance?

I was prompted tom ponder this by a short article by Daron Acemoglu in which he discusses the emergence and issues of what he calls our supply chain mess.

Extensive supply chains became the norm during the past few decades.  Corporations after corporation disaggregated it’s various processes and distributed them along these chains of activity.  Sometimes the chains were simply logical.  Most often they were expressed physically, and we ended up with a vast logistical network drawn across the globe each node of which depended on the operation of a multitude of others.  Just in time became the rallying cry of consultants and managers intent on squeezing what Acemoglu calls efficiency from the disaggregation of business activities.

Acemoglu sticks close to the standard explanation economists apply to this disaggregation.  By taking a business process apart and shifting some of it outside of the original firm’s boundaries so that it now occurs in a market context we are told efficiency rises.  This is taken as axiomatic.  Trade, in the standard telling, always increases efficiency.  The two sides both benefit in some way, so there is an aggregate gain.  Society is better off.

In the world of business management theory this breaking apart of business processes and the subsequent movement of pieces into the market is a consequence of the idea of core competencies first promulgated by Prahalad and Hamel back in the late 1980s and early 1990s.  I remember the emergence of this idea well: it caused quite a stir and was quickly taken up by all manner of firms intent on removing activities from their internal control that were not specific to their “mission”.

It is clear from this apparent coincidence between the standard ideas of economics as referred to by Acemoglu and of business as presented by Prahalad and Hamel that the notion of efficiency had jumped from economics into business practice.  Business theorists had adopted a key idea from economics and then turned into a practical measure to be applied by managers who wanted to be seen as cutting edge.  Our theories of the firm coalesced around this centrality of efficiency.  This is despite the controversial nature of what, exactly, we mean by efficiency.  More to the point: how do we even measure it in the face of endemic uncertainty?  Just what is an efficient firm?  How do we know when we hit that mark?

Of course, Prahalad and Hamel were riding a wave.  Their ideas were another indication of the invasion of business thinking by neoclassical theory.  Perhaps so-called agency theory is an even better instance.  It sprang to prominence during those same decades.  Its core idea was that there was an agent acting on behalf of a principal in many economic circumstances, and it then subjected that relationship to all the usual somewhat cynical  views of human relationships that populate standard theory.  Managers were suddenly agents of someone else rather than being administrators of an organization that was, itself, an independent being. And, given the neoclassical turn in economics at the time, they were agents of capital providers rather than anyone else.  Capital suddenly owned things rather than simply financing them.  Managers had to pay attention only to capital in the way described by Milton Friedman.

This brings us back to Arthur.  All these neoclassical ideas moving from economics into business practice represented a domain shift.  The previous set of technologies defining a business firm, its intentions, its social role, and the best methods for management, were all replaced by a new set drawn from the same root as neoclassical economics.  The underlying objectives of economics became the underlying objectives of business.  Instead of economics being the study of what goes on in the real world it became the source for what goes on.  It went from being a study to being an active agent in the landscape it sought to describe.  It became performative.  Economics, in this form, thus lost its independence.  It was designing the economy according to its current notions, no matter how controversial those notions might be.  Efficiency being one such.

So here we are in this tangled supply chain mess that Acemoglu describes but does not get to the heart of.  The mess is largely a consequence of the failure to account for uncertainty.  Which is an error of standard economics.  When, towards the end of his article, Acemoglu describes shareholder value as an ideology, he misses the opportunity to collapse standard economics into that same bucket.  After all the two occupy the same domain.  They co-exist as components within the same cluster of technologies.  If one is ideological, so is the other. The supply chain mess is a wonderful real world example of how economics fails in its relevancy to the problems that exist there.  The efficacy of global networks is subject to the uncertainties that all business faces.  The problem is that economics denies the importance of this uncertainty.  In its effort to simplify the world for tractable analysis it ignored real world features that turn out to be extremely important.  And when it then exported that simplification back into the real world in the form of business management theory it exported its naivety and led business astray.

Yes,  Arthur is correct.  Technologies are best thought of as clusters with common ancestors.  Shareholder value and neoclassical economics belong in the same family.  I just wish Acemoglu had been more clear in saying that.

One last thing. Talking of domain shifts: I wonder whether Arthur’s taxonomy needs a higher order or layer.  I agree that technological domains are a good analytical tool for studying the evolution of the economy.  But what of the larger scale?  What about a shift from a predominantly material economy towards a predominantly digital one?  If our institutions are technologies conceived to solve particular problems  and draw on a lineage of older technologies, what happens when a whole new lineage becomes possible?  What about the possibility of a technological Cambrian explosion?  One of the problems we face is that the opportunity to redraw our institutions based upon a strictly digital basis is being missed because we are over-invested in the older physical lineage.  The entire industrial era can be taken as one “epoch” manifested in all manner of social, political, and economic constructs.  Is the digital future a similar epoch?  Does it need new institutions?

Now that would be a domain shift to watch out for!

 

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More is Different: A Redux

“Formation is the vanishing of being into nothing, and the vanishing of nothing into being”

Hegel loved his dialectics.  But it isn’t just contrasts that illuminate reality.  It is connections also.  Connections matter.  Single things are interesting.  Perhaps even intriguing.  But it is the way in which things connect that leads us to the better understanding of our surroundings and of ourselves.

Our modern world rests largely on a web of technology that mediates our existence and removes us from our primitive origins.  We pride ourselves on this web.  Our ability to render nature compliant and exploit both our context and our intellect to produce comfortable lifestyles is the essence of modernity.  Any brief study of the past two hundred years will astonish us at the gulf in everyday existence between now and then.  We really do seem to have broken the Malthusian grip that nature held us within for so long.

A great part of that ability to break free consists in our imposition of reasoning on the problems previously preventing us from escape.  We learned to abstract.  We learned practical problem solving.  We learned both to reduce problems to solvable sizes and then to reconstitute solutions from those now-known component parts.  We created, to borrow from Brian Arthur, a reliance on modularity: we learned to build technologies from various parts.  And each part itself was itself modular.  The implied reductionism in this prompted the illusion that the method for superior knowledge was always through breaking things apart and re-assembling them once we knew what each part did.  

Economics took heed of this method and ran with it as if the economy was a technology comprised of parts easily assembled back into a whole.  Economics is justifiably proud of its internal logic.  But is it something that matches reality well?

We need to heed the words of Jorge Luis Borges, who warned us of “reasoning with an internal logic, where reality does not collaborate”. It is possible to fall for the efficacy of abstraction and to forget your purpose.  You can get stuck in a distant corner replete with an enormous library of logical components each of which is exemplary in its consistent splendor but each of which fails utterly to explain much. Except, perhaps, itself. Economics long ago, I am afraid, arrived in such a corner. It has become supremely good at explaining itself. It has become much less useful in explaining the economy. 

A major part of the problem comes straight from the “micro foundations” movement. This effort to explain all higher order phenomena as a simple extrapolation of lower order facts is a danger all scientific endeavor has faced. The problem for economics is that it has failed to re-invent itself subsequent to the modern realization that radical reductionism is a step too far. It soldiers on in defiance of the increasing understanding that the complexity of reality calls into being phenomena at higher levels that are not constructed of lower level parts. They exist only higher up. Connections matter. The hand of the likes of Prigogine is not felt strongly in mainstream economics. 

It may be true, to some extent, that a cloud is simply a bunch of raindrops, but there’s something profound being missed to imagine that “bunch of raindrops” is a sufficient understanding of a cloud. Yet that’s where economics totters along.  Aggregate phenomena are treated as just that, aggregations .  Even the name betrays the thought process.  As a result macroeconomics, once a venerable pursuit, is reduced to almost nothing with enormous policy and social implications. We are told that things “work in practice but not in theory”.  With a straight face. We are given presentations on such things as efficiency as if, at a higher order, it were possible to conceive of an efficient result.  What, exactly, is efficiency at a systemic level, when that system is an open flow subject to uncertain fluctuations and a near incomputable assemblage of information?  A trivial example is the feedback between supply and demand that sits at the center of economics.  Feedback is a connective and dynamic concept.  It says that the two components, in this case supply and demand, can never be thought of either as two separate phenomena and analyzed as such.  They can only be thought of as inextricably linked with neither having a separate existence.  When we iterate back and forth to explain how supply adjusts to demand or vice versa we lose our ability to analyze either by itself.  They now exist as a pair.  Any focus on either separately is rendered useless.  Supply and demand are functions of each other.  They bring each other into existence. Each relies on the other.  Studying either as if this was not true is to ignore the essence of the insight.  It is to fall for the reductionist illusion.  It is an abstraction too far.  It is to ignore Borges and to go somewhere where “reality does not collaborate”.

The result is not knowledge.  It is ignorance.  

A critique of reductionism is not some modern, novel, or radical phenomenon. The debate about complexity and its ramifications has raged for decades. As long ago as 1972 the Nobel winning physicist P.W Anderson could say the following, in an article titled “More is Different”:

“The main fallacy … is that the reductionist hypothesis does not by any means imply a ‘constructionist one’. The ability to reduce everything to simple fundamental laws does not imply the ability to start from those laws and reconstruct the universe”. 

Economics clearly paid no attention to Anderson. 

When we abstract for the purpose of elucidation we must be sure that the implied loss of information was worth the gain. We must be careful not to throw the baby out along with the bathwater. Or, put alternatively, we need to be truly humble about what we know when all we know is based upon the elimination of great swathes of information. 

Modernity is good at eliminating information. We do it all the time. We reduce the intensity of reality into more manageable pieces. We cast aside what we don’t need for the task at hand. We automate and thus eliminate the need for thought on the part of the production team. We rationalize and thereby smooth off the edges that might cause disturbance to the flow of thought. We gain deep insight this way, but at the loss of texture and context. We gain depth at the cost of breadth. 

Ever since the rise of industrialization we have narrowed the lens through which information passes. Our machines replace or amplify muscle power. So our contact with nature is removed from its immediacy and elevated into a more abstract realm governed by measurement, containment, and management. Each of which implies the elimination of information deemed unnecessary.  We engineer our surroundings and our workplaces rather than simply living in them. And each new technological advance adds to the removal of that direct contact. Layer by layer we lose contact with our origins and substitute in its place a mythic alternative with a far more limited information content. We steadily systematize the chaotic in order to extract value from it. We move more and more into a world of structured connections and away from the natural complexity in which we began. 

The steady accumulation of technology has resulted in a poverty of information even though we think of ourselves as living in an age of information.  Our rationalization of the natural world necessarily eliminates what we consider as irrelevant.  And by so doing we cast aside information.  The stimulus of the broad lens of nature is replaced by the narrow lens of constructed artificial reality. 

This steady loss of information, as we narrow the lens continually in order to overcome nature, leads us astray. We believe we are in control and are more knowledgeable when, in fact, we are increasing our ignorance. We begin to make leaps of thought that make sense in the confines of technological currency but which make little sense in the face of the unknown beyond. There is a great danger lurking in that lost information. And every so often it asserts itself and disrupts our so-called advance. Just when we think we are in control we realize we are not.  Such a circumstance reminds us of our deliberate ignorance.  It reminds us that our abstractions bring with them the risk that we stripped out information that might become relevant when we re-engage with the real world.  

Economics is a primary example of this process of casting aside information. 

It has reduced itself, by and large, the study of exchange, allocation, and distribution. It ignores any information not directly applicable to that study. So the needs of society become reduced only to those visible in such circumstances. Anything not involved in the process ending in exchange is stripped away. This abstraction opens the door to formal understanding of a very narrow facet of economic reality. It says nothing about social reality except that certain consumers are willing to pay price x for product y. Upon this simple matrix economics has built a host of observations that belie the simplicity of its basis. 

Economics has, in essence, taken the feedback mechanism between consumers and producers, called it grandiosely the market system and then imagined it has understood the relationship between human needs and the ability to satisfy them. It has not.

Then again, that feedback mechanism is about as good as we can hope for. To refine it further or improve upon it would require us all to be able to articulate our needs more clearly in ways that could be accumulated in to some sort of aggregate demand amenable both to study and satisfaction through organized production. Such an ability and the knowledge associated with it lie permanently beyond our cognitive capacity. The best we can do is to fudge. The best we can do is rely upon approximation and rely on the modest workings of the market to get what we can. 

Perhaps Hayek was right in his denial of the efficacy of central planning.  After all the complexity of reality means that a centrally arranged matching of supply and demand lies beyond our current ability.  But he was wrong to imagine that markets are in any way superior.  They, too, fail to match all needs with all possible solutions.  We simply have no way of knowing whether markets work well.  Any appearance that they do is simply an illusion.

And that’s the lesson of reality: a market is nothing more than a modest effort to meet what needs we can within the narrow scope of a limited flow of information. Is it the best we can do? Is it perfect? Is it better than anything else? Is it optimal? Is it efficient? We have no way of knowing. We lost the information to do those kinds of calculations along the way. And even if we had the information we wouldn’t be able to do the calculation. 

Pretending that such a modest mechanism as a market should dictate anything beyond its limited scope is a foolish error, which if we act upon it, imposes large costs on society as whole. Markets do what they do. Nothing more. Let’s leave it at that. Those connections matter.  Borges was right.  We should always ensure that reality collaborates with our efforts at logic.  The rest is fantasy.

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Is There a “Policy”?

I read this morning that the Federal Reserve had bought, at the peak of the recent crisis, about 40% of all US government bonds being issued.

This may, to some of you, be something of no concern.

Think again

The illusion that there are separate spaces for monetary and fiscal policy is belied by this fact.  Which one was it?  Was it the Fed flooding the economy with money?  Or was it the government issuing debt to finance economic activity? I suppose it was both.  But it wasn’t fiscal policy.  The effect of all that money was simply to support asset prices.  Whether that was the intention is irrelevant.  The flood found its way into the financial system and relatively little found its way into the economy in the form of an expansion of productive activity.  We could go further: a great deal of what expansion of capacity actually occurred went abroad to build fragile supply chains and take advantage of low wages in distant parts.

What also happened was that households sat on the portion of the flood that they received as a hedge against further economic mayhem.  And when, as now, they began to feel more confident they started to spend the money on goods rather than services.  Remember that the economy is heavily skewed towards consumption, and within that, towards services.  The problem with services is that they tend to be in-person.  And being in-person is something a lot of people are avoiding right now.  So they decided to switch and buy goods instead.

This, being the twenty-first century, those goods usually contain some sort of a computer chip.  Quite why we need our refrigerators to talk to each other is beyond me, but someone decided it has great value to us.  So everything nowadays is packed with the ability to communicate.  Which puts pressure on the chip manufacturers.

It also, coincidentally, puts enormous pressure on the people who move the chips around the globe because, this also being the twenty-first century, chip production is concentrated in far corners of the globe rather than near to where they might be incorporated into the final product.  This is the way of efficient supply chains.  Which, as we now know, is something of an oxymoron.

With the supply side of the economy so battered by both unexpected money-induced demand and the corporate delusion of efficient supply chains, we are now being bombarded by price increases.  This has given rise to the specter of inflation.

I hope you have noticed that inflation is always a specter.  It is a ghost that haunts the minds of serious people who, once they see workers demanding more wages, seek to damp such demands as being insidious.

But insidious to whom?

Asset holders of course!

The long term value of assets is eroded by inflation.  Those pesky workers demanding higher wages works to undermine that value by inducing a cycle of “inflationary expectations”.  That wages have been suppressed for eons in order to boost the profits earned by asset holders is left out of the discussion.  We must, at all costs, preserve those asset values.

So, in the face of a collapsed economy in, say, 2008, we pump in trillions of dollars of money.  This has the primary effect of ensuring asset holders don’t get taken completely to the cleaners.  Job well done.  The problem then becomes how to wean ourselves off the flood of money.  That’s easy: we wait for the economy to return to its long term trajectory and then ease off.  The presumed recovery in earnings prospects will offset any downside implied by removing the monetary life support.  Rising interest rates will prevent the specter of inflation undermining asset prices.  Wages will be contained within sensible bounds.  Profits will recover.  Asset values will flourish.

Phew.

Except.

What happens if the economy doesn’t return to its long term trajectory?  What happens if it wallows along sub-optimally, starved of investment, with low productivity and perpetually on the brink of a renewed downturn?

Well, in that case you keep flooding it with money.  Just like we did between the Great Crash and the Pandemic Crisis which provide bookends for a period of pretty awful economic policy.  Too little reliance of fiscal policy at one end and relentless floods of money throughout.  It was called quantitative easing.  In fact it was an addiction.

In the absence of an economic policy that put government expenditure of real activity at its heart, think of the bridges that could have been built with all that money, we monetized the debt instead.  We flooded the financial system with cheap money.  Indeed we ended up making money so cheap it has become incredibly difficult to increase its price.  It has made credit so widely available that even the most perverse investment opportunity is grasped as a possibility worth thinking about.  The search for returns has overwhelmed any sense of risk aversion.  Everything goes.  And like all addictions this will end badly.

We have produced an economy awash with debt and with asset prices higher than the underlying cash flows justify.  This is what happens when you ignore history and imagine that you don’t need proper fiscal policy.  Or, at the very least, that you distinguish between monetary and fiscal policies.

So now the central banks are stuck.  Having created an addiction they need to offset the inevitable withdrawal symptoms.  If they raise interest rates they might deflate asset values from their addiction riddled levels.  If they don’t raise interest rates they might abet the onset of an inflationary cycle that might deflate asset values from their addiction riddled values.

Whoops.

Meanwhile the bond market, in its current addicted state, prefers to believe that the central banks will continue to drip feed it sufficiently to prevent a decline in values.  How else can we interpret the contradiction between the constant refrain of the inflation specter being raised by bankers and their concurrent willingness not to bid up long term interest rates?

Interesting times.

So the Fed’s avowed intention to taper its asset purchases down to zero by mid 2022 looks like an exercise in hope and belief that something will turn up.  Which doesn’t sound much like “policy” to me.

But it will have to do.

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Modern monetary theorists will chortle at the above.  The constraint they prefer to rely on with respect to the flood of money is inflation.  Great.  Question: is the exchange of Fed-created money for Treasury-issued debt not a form of MMT?  After all it ends up as money.  And the debt becomes an issue only for those who talk about debt ceilings and “affordability”.  We talk flippantly about low interest environments being comfortable for the issuance of debt to finance government spending.  So we ought not concern ourselves about etc debt per se, only the cost of carrying it?  But who made interest rates so low?  Did we not manufacture the exact conditions within which debt is so cheap?  It sounds so circular.  Meanwhile why don’t we simply dispense with the illusion of debt to begin with?  Why don’t we recognize it as money at the source?  Why don’t we simply fund government with money?  If Fed-created money and Treasury-issued debt are so fungible why bother with the distinction?  In whose interest is it to maintain the difference?  Asset holders.  Now we know who policy is maintained for.  Surprise.

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The Sabotage of Efficiency

Sabotage.

Not the sort of sabotage we associate with plucky heroes undertaking dramatic action like blowing up railway lines and so on.

No, the sort of sabotage that is a great deal more subtle.  The kind that is summed up by the metaphorical boiled frog.  The slow devious and underhanded chipping away at something termite-like until the edifice is more fiction than fact.

That sort of sabotage.

The sort of sabotage that Thorstein Veblen wrote about a hundred years ago in his curious collection of papers later accumulated into the volume entitled “The Engineers and The Price System”.  I must admit that every time I read those papers I come away with a furrowed brow.  What on earth was Veblen getting at?  The argument ends with a reference to a soviet of engineers rising up in defiance of the various vested interests whose dead hand weighs heavily open the supposed efficiency of something he calls the industrial system.  The notion of a soviet had a very different connotation back in the early 1920s than it does now, and the industrial system was a novelty subject to a great deal of intellectual scrutiny.

This system Veblen describes is the development of modern production from its primitive roots in the work-at-home artisanal version at the beginnings of industrialization to the 1920s version that seemed at the time to be the height of complex interconnection and intricate interdependencies.  He puts a heavy burden on his engineers.  They are the class who understand the system best and are able to squeeze its efficiency to the ultimate degree.  And he is adamant: this system is the provider of all that society has come to depend upon.  Ownership of the assets within the system is one thing, but the beneficiary of the output is society as whole.  We, he argues, are dependent on the system.  So we have, by extension, become dependent on the goodwill and honesty of the engineers who, alone, can make the system work most efficiently.

The problem, then, is sabotage.

In one of the middle chapters of the book, called “Finance and the Engineers” Veblen describes the relationship between the then developing class of business managers, the external financiers, and the poor engineers whose efforts at creating ever more efficiency are inevitably undermined by the desire of vested interests to extract rents for themselves.  Business managers, we are told, don’t really understand the technology, but they do understand the way in which to subordinate the technology to commerce.  In particular they understand that optimization of technical prowess and optimization of profit are not the same thing.  They might, for instance, decide to throttle back on production, thereby depriving society at large of that extra product, in order to maintain prices and profit margins.  The financiers, to whom the business managers report, also accept and encourage this slowdown of production.  Since the assets within the system are supposedly “owned” by external forces — the clientele of the financiers — it is inevitable that the assets are underused.  The system is, in Veblen’s usage of the world, sabotaged by vested interests.  And society suffers.

This has an enormously contemporary feel.

Setting aside the oddity of this argument within the overall corpus of Veblen’s work, and setting aside his somewhat naive view of the motivation of engineers, it seems he is onto something.

As an aside:  it is difficult to decide whose view is more naive.  The economists who have busily constructed theories based upon ridiculously exaggerated rigor on the part of both producers and consumers or Veblen who is encouraging his engineers to resist the sabotage and thus become benevolent providers for society.

But Veblen was no fool.  He obviously understood that any economic theory positing that efficiency was the goal of an economic system was an absurd reading of real-world human objectives.  He also understood, I am sure, that efficiency is an elastic and elusive concept.

His insistence of the enormous complexity of modern industrial activity with its multitude of connections and dependency on the smooth workings of each of its parts in order for the whole to edge towards efficient outcomes is an acute observation.  He would have chuckled, surely, at our contemporary obsession with supply chains.  His engineers might have been able to foretell the failure of modern supply chains, but their voices would have been swamped by the sabotage of the investors whose eye on profit drove production into ever more tenuous tentacles reaching around the globe.  The impulse to offshore, outsource, or otherwise “globalize” was not an effort to squeeze more efficiency from the industrial complex.  Its was an effort to squeeze more profit for shareholders.  That the impulse was sold to society as an efficiency creating exercise is no matter.

Or, rather, in this case the sabotage was the co-option of the very concept of efficiency by financiers.  Their self-interest became the definition of efficiency.  So, whereas an engineer in Veblen’s telling might view efficiency as maximizing the output from a given set of inputs, our latter day financiers define it in terms of profit.  The two can, and most often do, contradict.  So the dominant version of “efficient” has become that of the owners of the inputs.  The asset owners.  And chronic underproduction and overpricing, not to mention fragile supply chains, are the result.

Society pays a high price for subordinating the determination of output to the pursuit of profit.

This is particularly true in an economy dominated by oligopoly.  The efficiency of textbooks relies on competition.  Our modern economy is very far from competitive.  It is, in truth, more rigid and thus inefficient than we are often told.  We underproduce as a result.  Our resources are poorly invested because they are diverted towards profit and not efficiency.  The textbook tells us that these are the same and that, ultimately, the pursuit of profit will ensure efficient allocation of resources.  But the textbook fails to understand Veblen’s saboteurs.  His explanation was that the sabotage was too insignificant, in his day, to be too damaging for society.  He did, however, warn that the steady increase in rent-seeking would ultimately undermine the workings of the textbook economy.  We would end up with a crisis of underproduction and overpricing.  The saboteurs would end up running the system for their own ends.

Which is what has happened.

We could argue, with a few of our own extended examples, that the current economic landscape is a consequence of the pursuit of profit-as-efficiency instead of maximum output-as-efficiency.  This is the gist of Jan Eeckhout’s excellent “The Profit Paradox” published earlier this year.  Eeckhout’s subtitle tells the whole story: “How Thriving Firms Threaten the Future of Work”.  The pursuit of profit does not fulfill the objectives assigned to it in the textbook. Not unless, that is, society maintains its vigilance in enforcing the rules that textbook accepts as axiomatic.  Most notably ferocious competition sufficient to drive down profit and eliminate the space for the creation of rents.

Another failure we can attribute to the profit-as-efficiency maxim is the steady rise of finance in our modern economies.  Instead of being a medium for the efficient allocation of resources towards output, finance has taken on a life of its own.  Assets, instead of being circulated back into the real economy to support output get stuck inside the financial system itself.  They accrue profit for profit’s sake.  They produce nothing.

This accumulation has been abetted by extraordinarily lax monetary policy.  The saboteurs have become so embedded in our system that they have to be protected.  Their survival has become the dominant policy objective.  So we create money to inflate their asset prices and enhance their holdings.  But very little of that money we create is channeled into production.  It gets sucked up by the banks, hedge funds, and sundry other intermediaries.  Because the long term sabotage of the vested interests has so perverted the economy that the rate of return available on investment in creating productive output is less than that available in non-production.  It is something a Keynesian could have foretold:  if we starve demand we starve the entire system.  If we suppress wages we suppress demand.  The suppression accumulates steadily to produce a system in which underinvestment in output becomes ever more profitable.  The incentive for asset owners is to hoard rather than take risks.  Underinvestment becomes underproduction.  It becomes the realization of Robert Gordon’s vision of stagnation.  It produces an addiction by asset holders to ever more doses of money creation to preserve asset values.

And it produces the absurdity of our current policy debates.  How do we withdraw the money that we created to bail out our asset holders without damaging them?  How do we extricate ourselves from an economy dependent on excessive flows of money without plunging it into depression?

Maybe we should stop paying attention to the saboteurs.  That, surely, was Veblen’s message and his warning.  He was correct: those financiers are just fancy saboteurs.  And sabotage is a very real thing.

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One more thing:  it occurs to me that all this talk about efficiency is something we need to take a good look at.  How can we even define an efficient outcome in a world of endemic uncertainty?  The economy is an open, not a closed, system.  It relies on inputs of energy and information, neither of which behave in the manner described in textbooks.  Efficiency is a chimera.  It is never achievable.  Which is why the concept is easily co-opted or perverted into whatever various vested interests decide it to be.  So maybe the source of the sabotage Veblen was talking about was economic theory, based as it was, on nineteenth century concepts that need to be updated if not thrown away.

But that’s for another discussion.

 

 

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