The financial crisis: Why did no-one see it coming, and why did economists get it so wrong?

Why didn’t the experts see it coming?, asked the Queen of England, and the British Academy wrote a letter to explain. Of the lead up to the global financial crisis they wrote:

“It is difficult to recall a greater example of wishful thinking combined with hubris.”

Meanwhile, economist Paul Krugman asked a similar question – how did economists get it so wrong –  and came up with an answer to do with the difference between salt water and fresh water (apparently one turns you Keynsian and the other turns you neo-classical). Krugman noted the failure  of neoclassical economics to account for the apparent irrationality of the market, and proposed as a remedy the emerging sub-discipline of behavioural economics.

When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly.

Both these approaches – that of the British Academy highlighting wishful thinking and hubris, and that of behavioural economics highlighting cognitive biases – make the great mistake of assuming that there is a single ‘ideal’ rationality,which real humans happen to be incapable of attaining. Continue reading “The financial crisis: Why did no-one see it coming, and why did economists get it so wrong?”

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How to avoid nasty surprises

by Kevin N MurphyThe company had a “uniquely entrepreneurial culture” that made it a paragon of business success. According to management guru Gary Hamel, it was ‘leading the revolution’. Unfortunately the company in question was rotten to the core and ultimately became one of the most notorious business failures of the decade. The company, of course, was Enron. Hamel later said,

“Virtually everyone inside and outside the company was surprised.”

The message of grid-group cultural theory is that a focus on one means of organising to the exclusion of all others will tend to look like success – at least to those who share that worldview. But in the long run, the pressure of reality will impinge, and what looked like an asset will be revealed as a liability. The theory holds that there isn’t just one worldview – there are four, and we ignore this plurality at our peril.
Alan Greenspan had a similar surprise at an even larger scale as the US economy began to unravel. In April 2008 he wrote that events had left him ‘surprised and appalled’, and yet

“My view of the range of dispersion of outcomes has been shaken, but not my judgment that free competitive markets are by far the unrivalled way to organize economies.”

By October 2008, though, this shaken intellectual edifice had fallen completely:

“Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity — myself especially — are in a state of shocked disbelief.”

From the perspective of the Four Cultures, Greenspan’s one-eyed, single-minded pursuit of deregulation, far from being a positive attribute, was surely going to end in tears. As Joseph Stiglitz put it,

“key regulators like Alan Greenspan didn’t really believe in regulation; when the excesses of the financial system were noted, they called for self-regulation — an oxymoron.”

Stiglitz says,

“This is not the first crisis in our financial system, not the first time that those who believe in free and unregulated markets have come running to the government for bail-outs. There is a pattern here, one that suggests deep systemic problems…”

Sadly, though, Stiglitz’s solutions to the financial crisis are cosmetic, not systemic. Worthwhile though they may be in their own right, they will do little to improve the systemic problems with a political and financial culture that refuses to see that there is more than one way – or two at a push – of doing things. Stiglitz’s approach – a financial product safety commission, a financial systems stability commission and so on – is typical of the now commonplace shift from an Individualist culture (deregulation, free-market, unbridled competition) to a Hierarchical culture (re-regulation, constrained market, suspicion of competition).

Mary Douglas, the originator of the grid-group paradigm, showed that there is far more to life than just hierarchies or markets, but neither Greenspan or Stiglitz seem able to see that. Set in proper context, markets and hierarchies are just two of a wider suite of responses to the challenge of organising.

And until we move beyond the limited range of responses currently on offer, towards solutions that make the best of all four of the cultures Douglas identified, we’ll just keep on being surprised.

See also:

Mutual alternative to markets and hierarchies