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The Price of Economics

Thank you Mariano Torras.

You said the following in a letter to the Financial Times:

“I would venture that there is a professional motive for perpetuating — through the use of elegant and abstract models — the fantasy that economics is a science.  The prestige, the stature and influence that such a myth permits is undeniable.  Yet, far more perniciously, the ostensible neutrality of “economic science” provides seemingly unshakeable ideological cover against critics who (more realistically) accentuate power, inequality, and politics.”

That about sums it up.

Economists do not study economies.  They study economics.  They study their own models and other stylized facts in ever more detail and abstraction.  They have substituted technical wizardry for contemplation.  They privilege mathematics over other kinds of analysis.  And they scrupulously avoid entanglement with history which might drag them into a conversation about just how they arrived atop Mount Economics far above the plains of reality below.

Professor Torras inspired me to dig out the following:

“More generally, how does a scholarly community determine that a proof is valid, especially when the proof is highly complex and when there are few people in the community with the technical skill to understand the proof? And what might “understanding a proof” entail?”

That’s Roy Weintraub speaking in his excellent book ”How Economics Became a Mathematical Science”.  Go read the book.  It’s highly instructive.

But it isn’t my intention to poke too much at the mathematicians we now call economists.  It isn’t for me to say whether economics has progressed as a consequence of restricting itself to the confines of applied mathematics.  The profession seems comfortable to be so restricted.  It wallows in its arcane nook and appears content to portray itself as a repository of analytical capability rather than of economic insight.  That’s all we need to know.

A broader question is worth delving into though.

How do people outside of the profession know that what economists state as knowledge is actually worth knowing?  How does anyone not within the hallowed halls and not grounded in the accepted or iconic modeling know that the knowledge professed to be possessed by economists is actually worth anything?  Anything at all?

They can’t.

They have to take it on faith.

This is an inevitable and dangerous consequence of the relentless division of labor that Adam Smith so capably foretold was the future of society.  Endless and ever finer slicing of activities in order to open up slivers to be monetized or brought within the sphere of a marketplace has produced a great deal of ignorance.  For everyone of us not an expert in something must be ignorant of it.  And there are ever more things to be ignorant of.  Our modern prosperity rests squarely on such slicing.  Nowadays we monetize just about everything.  We prosper because of our individual ignorance.

None of us has the expertise to judge whether what we are told has validity or worth.  We find ourselves at the mercy of countless so-called experts.  We live in an era of technocracy.  

Many years ago I came across an excellent book by Philip Davis and Reuben Hersh.  It is called “The Mathematical Experience”.  I think it was published in 1980.  One of its chapters deals with exactly the problem I have identified above.  Only in this case the profession in question is mathematics itself.

The chapter revolves around a fictional professor of mathematics who, we are told, is a world expert in something called non-Riemannian hypersquares.  The community of other experts in his field is very small.  They hold all the usual conferences.  They publish all the usual papers.  They confer all the usual PhDs.  They delve deeply into their specialized topic with all the zeal that we expect from our seekers of truth.  And they make comments, so we are told, like this:

“If you apply a tangential mollifier to the left quasi-martingale, you get an estimate better than the quadratic, so the convergence in the Bergstein theorem turns out to be off the same order as the degree of approximation in the Steinberg theorem”.

This, of course, is a spoof.  Or, I think it is.  How would a layman like myself know?  How would you know?  

The more important point is that within our complex society, with its arcane nooks and crannies of so-called expertise, how is the population at large to trust anyone who talks like that?  It is an evident attempt at avoiding making something intelligible to the non-cognoscenti.  

Worse, quite often the denizens of such nooks and crannies go to great lengths both to hype their apparent knowledge and to prevent invasion into their worlds by those outside.  They act like the guilds of yore.  Setting the rules.  Policing the required curriculum.  Protecting their value by placing restraints on who can or can’t be thought of as an expert.  And by using every trick in the book to be perceived as valuable, at least to those “in the know”.  Peer review is supposed to act as a quality control.  But who are the peers?  

Milton Friedman was fond of arguing that the medical profession was a restraint on trade.  The marketplace, he argued, would sort out what advice and treatments had value.  I wonder what he thought of his own trade?

One of the great ironies of economics is that it, too, acts as a guild.  It decides what economic knowledge is good and which is bad.  It selects only certain parts of its own history to create the “right” narrative.  It tells its own stories of what it wants outsiders to know.  And it defies, quite often, its own teaching by so doing.  After all, economics tells us that restraints on trade are harmful to the great fulfillment of the harmonic perfection of market efficiency.  So why are there tenured professors of economics?  Tenure is a restraint on trade.  Where are the market forces determining what economics is or is not?  Ought those professors  not step down from tenure and expose themselves to a proper market for whatever it is they are selling?  Isn’t that, then, the method we ought employ to determine the value of economics?  

The discipline of economics is no different from any other pool of expertise.  Those on the outside must judge it by its contribution to the well-being of society at large.  In this case its ability to predict economic activity.  Or its ability to foretell the beginning and end of cycles of growth.  Or its ability to describe the sources of growth and the distribution of wealth in society and to predict …  

Well, no.  I am told that’s unfair and that I don’t understand the purpose of economics.  It isn’t to predict.  It is to explicate.  It is to look backward and not forward.

So here we are with economists littered throughout the policy-making world employing their hard-won technical expertise and affecting the lives of millions upon millions of other people.  Those other people trust that the economists know what they’re doing.  Just like we trust doctors.  Or dentists.  Or psychiatrists.  Or any other profession with a code of ethics to ensure the efficacy of the knowledge society has come to rely upon.

No code of ethics?

No problem.  Economics teaches us that the market for ideas will weed out the quacks.  How convenient.  So economists don’t need a code of ethics.  See how useful it is to think like an economist?

How do we put a price on economics?  Or anything come to think about it.

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Share Buybacks — Again?

What isn’t said is often more telling than what is.  The silence denotes either a disrespect for thorough analysis or an ignorance of issues beyond the ken of the speaker.  Then, of course, a third option arises: that those issues are an embarrassment to the point being made and are thus best left unmentioned.

For some reason stock buybacks appear to fall into such a zone of silence.  There is some controversy currently about the topic because of the recent proposal to impose a very modest tax on stock buybacks here in the U.S.

The usual arguments have been put forward to defend buybacks.

Michael Mauboussin, who is head of something called consilient research in an arm of Morgan Stanley, recently wrote this in an op-ed for the Financial Times:

“An essential role of an efficient economic system is the reallocation of capital away from businesses with limited prospects to those with more potential. Buybacks facilitate this process, and nearly all of the proceeds are reinvested in the shares of other companies.”

All you need to know about the oddity of the topic is contained within these two sentences.

The first is a bland statement about the pros and cons of financial markets.  Capital allocation is the central purpose of the activities of the myriad of actors collectively known as the financial system.  We can argue about the success and failure of such a system, especially with the financial crash of 2008 still in our recent memories.  Clearly the system is subject to major failures.  Misallocation can occur with alarming frequency and force.  Keeping what turned out to be a rotten and self-serving system afloat cost us all dearly.  Its manifest flaws have never been addressed, and it is back to such self-congratulatory opinion as the Mauboussin piece.  Self-awareness is not a strength on Wall Street.

With this said, it is the second sentence that ought to give us pause.

Buybacks, we are told, facilitate the process of capital allocation by withdrawing capital from businesses with “limited potential” and re-allocating it to other companies.  Presumably these other companies have greater potential.

But that is not what happens.

The re-allocated capital goes back to shareholders very few, if any, of whom invested in the business now viewed as having limited potential.  They bought their shares in a secondary market.  They are very unlikely ever to have handed over capital to the business in question.  They simply own shares.  And shares do not, after their original issue, represent investable cash for a business.  So the cash that is returned to a shareholder by way of a stock buyback scheme does not necessarily flow into the capital accounts of another business.  It is far more likely to flow into purchases of shares of a business adjudged to produce a higher market rate of return for the lucky shareholder.  The capital re-allocation that actually takes place is simply a re-balancing of stock portfolios, it is not the movement of capital from one business balance sheet to another.

The re-allocation argument is thus fatuous.

That deals with what was said.

Now to deal, once again, with what is left unsaid.

And here I am repeating myself, but the point has to be made.

It is the use of the word “return” that ought raise our suspicions.  

Here is an example, taken from the same op-ed piece:

“While buybacks provoke rancour, dividends are viewed much more favourably. In both cases the company is returning cash to shareholders. But buybacks differ because of sorting, taxes and attitude.”

Returning cash?

When, exactly, was this cash given to the business?  To return something implies an earlier gift, donation, or transfer.  But there has been no such gift.  None.  As I mentioned above, the shareholders who benefit from the buyback, are highly unlikely ever to have provided capital to the business.  So there is no question of a “return”.  This is simply financial-world jargon for the sequestering of capital on behalf a privileged group whose claim to ownership of that capital is based, not on a prior gift to the business, but on the basis of having bought in a secondary market a claim against the business.  There is no return.  There is simply a claim.

And that claim is based on the shaky and erroneous footing that, somehow, shareholders “own” the business.  They do not.  An incorporated business — the sort that might indulge in gifting capital to its shareholders — owns itself.  This is a matter of logic.  The business is incorporated.  It then secures funding.  The provision of capital comes, sequentially, after the formation of the business.  Thus the business pre-exists the capital and is not owned by the capital providers.  That this error has been sidelined by the law and financial practice through the years does not invalidate the logic.  

People who have provided financing to a business are well within their rights, in our current system, to secure certain privileges in return for their cash gift.  For instance, they can secure a claim against the cashflow of the business.  That this, somehow implies ownership is a fiction that has become a fatal fact.  That it transforms a gift from the business to sundry shareholders into a “return” of capital is an insult to everyone else involved in the livelihood of the business.  

And this is the critical part left unsaid.

The deformation of thought that results from this fictional perspective on the excess cash within a business hides from view alternative uses for that excess. 

The singular channel that the fiction imposes on the financiers means that they ignore the possibility of lower prices of the business products.  This would “return” some of the excess to the people who keep the business afloat by buying its wares.  Surely the consumers have a justifiable claim against the excess.  Most economic theory would certainly support such a gesture.

Alternatively, some of the excess could be returned to the business’s workforce who, presumably, have contributed to its accumulation by forgoing higher wages.  Their generosity surely deserves recognition as much as, if not more than, any shareholders whose commitment to the business is likely to be wafer thin and proven so by their keenness to take advantage of the gift of cash represented by a stock buyback.

It is no great revelation that the theory defending stock buybacks is part of a greater whole designed to provide capital owners with a privileged position in the pantheon of the activity we call business.  This has become a pernicious problem and one in need of proper debate.  If we are to tolerate private ownership of businesses, and I err in favor of such a thing, then we need to be honest about the implications and not hide the power and privilege such ownership can bestow behind false theories.  We ought to measure it carefully and put severe limits on it to prevent distortions in capital allocation becoming endemic.  Pretending that stock buybacks are a return of something — something never given in the first place — is preventing us surfacing that honesty.

It is thus upsetting that the op-ed I have been mentioning ends with this:

“Bashing buybacks may have political appeal, but financial literacy demands that their role, backed by substantial empirical research, be better understood.”

Financial literacy?

That ought to be more broadly based than a narrow and contrived peon to power and privilege.   Ought it not?

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“L” is for Lumberjack

Pick up Daron Acemoglu’s outstanding textbook “Introduction to Modern Growth” and open it randomly to any page.  There before you will be a few lines of text scattered amongst a variety of mathematical equations of varying density, complexity, and inscrutability.  It really is a wonderful book and pulls together all the wisdom existing in economics concerning the causes of that most intriguing of all questions: why and how does the economy grow?

Along the way you can be exhilarated.  You can discover the font of eternality in the notion of perpetual youth. You can see the future stretch to infinite horizons.  You can mingle with your ancestors in overlapping generations.  And you can wallow in theorems, proofs, and sundry other entertaining and sometimes difficult flora and fauna of modern economics.  

Amazing stuff.

And not only exhilarating but solidly logical.  The purpose of the pages of mathematics is to extinguish sloppy thinking from mere narrative.  It is to expose the subtleties and connections that elude us in simple speech.  It surfaces those vague notions that clutter and make ambiguous what might appear to the less mathematical as acceptable explanations of the phenomena of growth.  

This is the triumph of the mathematization of economics.  No sloppy thinking is allowed.  The various models presented in Acemoglu’s book represent a complete tour through the subject.  They are a complete odyssey.  They begin with the iconic first steps of Solow, and move through everything that has followed.  The technical progress of the discipline is astonishing.  Model after model is presented and explained in a sequence that draws us through decades of intense discussion and argument.  The elegance and pure logic on display is a testimony the those decades and to the never ending quest to produce explanations for growth that suffer from none of the failings of a merely verbal exegesis of the subject.

I tip my hat to the effort.  It’s a breathtaking achievement.

Now.  

One more thing.

That “L”.

Labor?

I always thought that “L” was for lumberjack.  All these years I have been wrong.  Those amazing models are including “labor” not “lumberjacks”.  How wrong I was!

But labor it is.  

That’s clear enough.  I mean we wouldn’t want to specify what we mean by labor would we?  It might be lumberjacks.  It might also be brain surgeons.  Or gardeners.  Or machinists.  Or artists.  Or economists [no, not that one!].  Or … well just about anything.  

That doesn’t matter though.  Who needs precision?  Who needs to be clear when all that modeling logic offsets any vagueness in the thought process?  The point is to eliminate mistakes in logic.  The point to to elucidate hidden connections and threads of thought.  The fact that the very raw material being modeled is vague doesn’t matter.

Does it?

I think it does.

I wouldn’t allow such an element of vagueness to infest a story I wrote.  Not at least if I wanted to be clear.  If I wanted to hide my uncertainty, however, I might just lull the reader with an ambiguity of specification.  I might, for instance, use the word “labor” and let the reader decide whether the object being described or analyzed was a lumberjack.  Or a brain surgeon. Or a gardener.  After all they’re all the same.  No?

Anyway, it’s nice to see the humility of economists.  All that hard earned and expensive skill.  Especially the mathematics.  And they’re all so humble that they don’t mind being confused with lumberjacks.  Not at all.  They’re all the same.  No?  All labor is the same.  It must be.  Or at least it must be to economists.

With a simple all-inclusive “L” we can substitute anyone for anyone else.  We could, for example, hear a lumberjack opine on a real business cycles or watch an economist climb that one hundred foot red oak in my backyard and prune away all those dead branches.  Labor is all the same.  No?  A lumberjack would laugh at the absurdity of it all.  Why don’t economists?

No amount of mathematical wizardry can eliminate the fog if the objects being modeled are allowed to remain foggy.  Modeling fog, however sophisticated the mathematics, still produces fog.

Allow me to introduce you to Total Factor Productivity.  Some people call it a measure of our ignorance.  I prefer to think of it as a quantity of fog.

Q.E.D.

As they say.

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Trussed or Bust?

Ten seconds.

Oh, maybe fifteen.

That’s how long it takes to realize that there will be no change.

Not, at least, if the morning’s op-ed in the Financial Times is to be believed.  Written by Kwasi Kwarteng the article is, I assume, an effort to anticipate potential critics and to set forth the outline of an economic game plan for the new Truss administration in the UK.  The administration is new.  The policies are, however, a tad threadbare.  They are well worn to a degree that suggests a complete lack of novel thinking.  These are early days though, so let’s hope that Kwarteng has something else up his sleeve when he takes over as Chancellor.

The problem for the author of the article is that the Conservatives have been in power for twelve years already.  So this is, essentially, their economy.  So to say the following is a bit odd:

“The same old managerialism has left us with stagnating economy and anemic growth, with labour productivity growing at just 0.4 per cent a year since the financial crisis.  taxes are now at their highest in 70 years.  This toxic combination needs to be urgently addressed.”

Toxic combination?  Same old managerialism?

Twelve years in and the Conservatives, having produced old managerialism and a toxic combination of low growth and high taxes, now realize the error of their ways?

A less cynical reader of the article than I would surely then look for both a repudiation of the last twelve years and an outline of novel ideas to accomplish this new start.

Such a reader would, I fear, be disappointed.  There is nothing Kwarteng says that has not been said during those twelve fateful years he seems to be in a hurry to brush aside. For instance:

“This means cutting taxes, putting money back into people’s pockets and unshackling our businesses from burdensome taxes and unsuitable regulations.”

Forgive me while I yawn.

Since this is normal neoliberal claptrap — it looks suspiciously like the normal trickle down rubbish that has failed for forty years — what, exactly have the Conservatives been doing these past long twelve years?  Writing unsuitable regulations?  raising taxes on business?  Wasn’t one of the main objectives of Brexit to rid the UK of all those mountains of rules imposed by distant bureaucrats?  Has that not worked out the way the Brexiteers expected?

Actually we know the answer to the regulatory question.  Brexit has added to the regulatory burden.  The Brexiteers, in the zeal to get the deal done, failed to notice that in order to trade with Europe UK businesses had to adhere to European rules.  This were the exact rules that Brexit was meant to get rid of.  Then, in order to declare sovereignty over regulation, the Brexiteers added a wad of purely British regulations.  So business ended up having a bigger mountain of rules to pay attention to than pre-Brexit.  But we aren’t supposed to notice.

I have advice for Kwarteng: in order to reduce the regulatory burden he could simply revert back to Euro rules and get rid of all the UK-only rules.  Of course, having left the EC, the UK will simply have to follow along and have no input into any future rules, but at least the burden would be reduced.

Another insight into how backward looking the new regime wants to be is the following, which is supposed to an answer to the problem of getting things back on track “for good”:

“That means focusing on how we unlock investment and growth, rather than how we tax and spend.  It is about growing the size of the UK economy, not burying our heads in a redistributive fight over what is left.”

Does the phrase “lifting all boats” mean anything to anyone at this point?

This is so old hat that even someone as steeped in the past forty years as me might be forgiven for reaching for a history book to examine the origin of it.

Let me see.

We are cutting taxes in order to unlock investment.  That’s a form of redistribution.  Upwards of course.  Tax cuts of the conservative kind always benefit the upper echelon, after all they have the cash we need to be invested, so any “unlocking” implies leaving them with more after tax income.  Then, after redistributing upwards, we are supposed to stop “burying our heads in a redistributive fight over what is left”.  Interesting.  What is left will be smaller.  Kwarteng is quite clear that the new administration is committed to small government.  So we are told to expect smaller budgets.  The redistribution of those smaller budgets would, under normal circumstances, be a little more fraught than were the budgets more spacious.  But, never fear, we are not going to get bogged down in such fighting.  The Truss era is a sunny one devoid of ugly redistributive chatter.  All those happy boats will be sufficiently lifted that it will occur to no one to worry about the distributive impact of small government and tax cuts that benefit the wealthy.  Social services will miraculously be fully funded because … well because all that growth will produce higher tax revenues.

Forgive me for my lack of enthusiasm.

This is so out if date and totally discredited that I worry for the FT.  Presumably it printed the article as a courtesy to the incoming financial team.  As a segment of modern fiscal management, however, it suggests there will be nothing new.  After twelve years in power, and having produced the post-fiscal crisis economy, the Conservatives have, apparently, nothing new to say.

And this represents a challenge.  Because, in his conclusion, Kwarteng says that we have nothing to fear.  Truss will reject the failed consensus.  It’s just that she represents the consensus.  So does Kwarteng. So when he says we ought not fear anything, we ought be really fearful.

Plus ca change.

 

 

 

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Tax Stock Buybacks?

Taking a short break from my crusade to get information taken more seriously in economics …

Yesterday’s Financial Times includes, on page 9 of the print edition, one of its regular “Market Insights” columns.  This is the space the FT allocates to sundry financial market types to opine on subjects of general interest to other financial market types.  It’s always a good read if you want to gain insight into how our magnificent financiers talk to themselves whilst allocating capital appropriately around the economy.  Well that’s what they see themselves doing, so let’s not nitpick.

The column yesterday was written by a luminary of the investment community, someone who sat on the board of a popular retirement fund, and who has written extensively on subjects related to finance, investing and so on through the years.  The subject was the possibility of eliminating the new tax that Congress just established on stock buybacks.  The new tax, all of 1% and thus hardly onerous, has stirred up a ton of ire in the corporate world where stock buybacks are viewed as a centerpiece of good “stewardship”.  That is if you consider stewardship to be centered purely on making shareholders happy.

Stock buybacks have become a go-to method for boosting stock prices at appropriate moments — dare I say just before the CEOs allocation of stock vests?  No that’s me being too cynical.  They have also become accepted as part of the arsenal of good governance of a modern corporation.  Excess capital ought, in the absence of new internal investment opportunities, be returned to the shareholders so that they can then re-allocate it in their portfolios to higher return projects.  It sounds so anodyne when you say it out loud that way.  And from within the hermetically sealed bubble of high corporate finance it is extremely sensible.

Except.

Let’s face it, it’s a tax dodge.  The corporation could pay the cash back as a dividend instead,  But that’s subject to a different tax rate.  Share buybacks make more sense.  They are “tax efficient”.  What an ugly and laden term.

So, the article’s author says, as the cash flows pile up and there are apparently no great opportunities for managers to use it within the day-to-day business, why not give it “back” to the shareholders?  And that new 1% tax is simply an unnecessary dabbling in management by an ungrateful and perhaps spiteful Congress.  Besides, gasp, it might make American business uncompetitive.  If all it takes is a paltry 1% tax on stock buybacks to make American business uncompetitive, then I suggest there are bigger problems to remove.

What the author doesn’t consider are alternative uses for that excess cash.  In his mind it is either retained within the corporation or it is “returned” to the shareholders.  I have other suggestions — I am trying to be helpful here.

How about lowering prices in order to reduce excess cashflow?  Pass the benefit along to consumers.  That would be one option.  It’s one that economics text books like.

How about raising wages?  Or, if you want to be conservative, paying out bonuses to your workers?  That would be another option.  The economics textbooks wouldn’t like this one unless each workers marginal productivity has gone up.  But we can try.

I am just trying to be helpful!

Either of those might get rid of the awful headache of having too much cash on hand.  Both might garner more support and/or enthusiasm for the corporation.  Just think: if people and workers look more kindly on the business they might be more apt to consider those alternative new products that the corporations is currently shelving.  You never know.  The business might grow and gobble up that excess cash.

Who knows?  It’s worth try.

Now, about the scare quotes I put around a couple of words up above.

I object to the trope that corporate cash is the property of shareholders and thus could be given “back” or “returned” to them.  Very very few of the current shareholders have ever contributed cash to a modern corporation.  They have simply bought paper in a secondary market.  They do not “own” the corporation’s cash.  That cash is the property of the business to use as it sees fit.  Like pay workers more.  The idiotic notion that good corporate governance begins and ends with the relationship the business has with the owners of whatever paper it issued in the past is one of the reasons that the economy is less vibrant than in the past.  Good governance extends beyond that.  Way beyond.  The error of blind attachment to the concept of shareholder value is a tragic one for workers, consumers, and society at large.

So let me repeat: yes, there are options for the use of the excess cash beyond stock buybacks.  Like lower prices or higher wages.

That a doyen of the investment community doesn’t comprehend that, or acknowledge it, is a sign of how far we have to travel if we are to rebalance the economy and society away from the real excess: our over-emphasis on finance.

 

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