Lionel Robbins Memorial Lectures Economic Freedom and Public Policy: Economics as a Moral Discipline Lord Turner Chairman of the Financial Services Authority, the Climate Change Committee and the Overseas Development Institute Howard Davies Chair, LSE
Lionel Robbins Memorial Lectures Economics after the crisis: Objectives and means Lecture III Economic Freedom, Public Policy and the Discipline of Economics Adair Turner London School of Economics 13 October 2010 1
Starting Point: The Instrumental Conventional Wisdom Allocative Human Free Growth efficiency happiness markets Free Inequality: Justified because it helps deliver growth markets 2
Happiness and income per capita in the USA Source: Bruno Frey & Alois Stutzer, Happiness and Economics , Princeton University Press, 2002 3
Income and Human Contentment: Possible stylised pattern over time Pre-industrial societies The Great Transformation Income / Contentment Income Developed economies Human wellbeing contentment / happiness China Africa Economic and technological progress 4
Three distinct reasons why relative income matters 1. Rising Concern for relative expenditure on status in itself fashion and Higher branded goods relative income increases Happiness 2. Increased competition Relative income happiness a function for inherently limited influences absolute of others’ supply positional goods living standard income as well as own Rising average incomes 3. Congestion externalities degrade quality of some forms of consumption 5
“Distributive” versus “creative” activities � “Creative” Increasing the net real income available for consumption � “ Distributive” Winning increasing income at expense of others Source: See Roger Bootle, The Trouble with Markets, chapters 4 and 5 6
Health and social problems Income Inequality Source: Wilkinson & Pickett , The Spirit Level , Penguin 2009 7
USA debt as a % of GDP by borrower type ���� ���� ���� ���� Corporate ���� ���� Household ���� ���� ���� ���� Financial ��� ��� ��� ��� 1929 1929 1935 1935 1941 1941 1947 1947 1953 1953 1959 1959 1965 1971 1971 1977 1977 1983 1983 1990 1990 1996 1996 2002 2002 2007 2007 Source: Oliver Wyman 8
Global issuance of Collateralised Debt Obligations: Cash and synthetic 300 Synthetic 250 Cash 200 $bn 150 100 50 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: IMF Global Financial Stability Report, 2006 9
Complete markets as a route to… … efficiency … and stability Credit derivatives “enhance the “There is a growing recognition transparency of the markets’ that the dispersion of credit risk collective view of credit risks.. by banks to a broader and more [and thus]… provide valuable diverse group of investors has information about broad credit helped make the banking and conditions and increasingly set overall financial system more the marginal rice of credit. resilient … Therefore, such activity improves The improved resilience may be market discipline” seen in fewer bank failures and more consistent credit provision”. IMF, Global Financial Stability Review , April 2006 10
Share of the financial industry in US GDP % 9 8 7 6 5 4 3 2 1 0 1850 1910 1850 50 70 90 1910 10 30 50 70 90 Source: Philippon, T (2008), The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence. (As referenced by Andrew Haldane in The Future of Finance, LSE Report, 2010) 11
Historical 'excess' wage in the US financial sector 'Excess' wage 0.5 0.4 0.3 0.2 0.1 + 0.0 - 1910 2000 0.1 1910 2000 10 11 12 13 15 16 17 18 20 21 22 23 25 26 27 28 30 31 32 33 35 36 37 38 40 41 42 43 45 46 47 48 50 51 52 53 55 56 57 58 60 61 62 63 65 66 67 68 70 71 72 73 75 76 77 78 80 81 82 83 85 86 87 88 90 91 92 93 95 96 97 98 00 01 02 03 05 Source: Philippon, T and Reshef A (2009). Wages and Humal Capital in the US Financial Industry: 1909-2006 , NBER Working Paper No 14644.A. Resh (As referenced by Andrew Haldane in The Future of Finance, LSE Report, 2010) 12
� Growth not the objective but by-product of other desirable objectives � Policy implications � Implications for the discipline of economics 13
The case for growth � Growth in low and middle income countries � The poor in rich countries � Economic regression in absence of markets � The journey, not the destination � Economic freedom as an end per se + Avoidance of involuntary unemployment 14
The internally contradicted argument � Economic growth in rich countries still matters because it matters to poorer citizens � Economic growth is maximised by significant inequalities / incentives � Therefore don’t worry if economic growth is combined with increasing inequality 15
The case for growth � Growth in low and middle income countries � The poor in rich countries � Economic regression in absence of markets � The journey, not the destination � Economic freedom as an end per se and avoidance of involuntary unemployment 16
Keynes, The General Theory “There is social and psychological justification for significant inequalities of incomes and wealth… … dangerous human proclivities can be canalised into comparatively harmless channels by the existence of opportunities for money-making and private wealth which, if they cannot be satisfied in this way, may find their outlet in cruelty, the reckless pursuit of personal power and authority, and other forms of self- aggrandisement. It is better that a man should tyrannise over his bank balance than over his fellow citizens.” (Chapter 24) 17
The case for growth � Growth in low and middle income countries � The poor in rich countries � Economic regression in absence of markets � The journey, not the destination � Economic freedom as an end per se and avoidance of involuntary unemployment 18
Happiness, income and changing aspirations Aspiration 1 Aspiration 2 Happiness Aspiration 3 3 2 1 Flat line of long-term happiness Income 19
The case for growth � Growth in low and middle income countries � The poor in rich countries � Economic regression in absence of markets � The journey, not the destination � Economic freedom as an end per se and avoidance of involuntary unemployment 20
Amartya Sen, “Development as Freedom” “… the freedom of people to act as they choose in deciding where to work, what to produce, what to consume…” “The merit of the market system does not lie only in its capacity to generate more efficient culmination outcomes but also in the processes by which those outcomes are achieved” (Chapter 1, The Perspective of Freedom ) 21
� Growth not the objective but by-product of other desirable objectives � Policy implications � Implications for the discipline of economics 22
Four clear policy implications � Maximise stability and minimise downsides • Financial regulation and macro-economic management • Climate change mitigation � Maximise public choice: especially at local level � Minimise positional goods competition • Welcome population stabilisation 23
Happiness, already achieved income, and changing aspirations Plus: Happiness Happiness as 1 2 3 4 function of relative as well as absolute income Income 24
Do we “need to grow” to afford public expenditure? � Health In general no, if main cost is salaries which rise proportionally with average GDP per capita � Education � Debt servicing Yes, if macro-instability or fiscal profligacy generate high stock of debt relative to GDP 25
Costs and benefits of higher capital and liquidity standards Possible costs to GDP growth • Long-term? Benefits of reduced probability Vs of negative setbacks • Transitional � Standard evaluation techniques • Compare costs & benefits using a discount rate which accords equal weight (in any given year) to costs and benefits � Consequence: will undervalue stability and over-value minor increments to growth, if people highly value already achieved wealth/income and avoided unemployment, and deeply dislike setbacks 26
Estimating GDP Measured value of � Long-term trends and financial services? cross-country comparisons between Distributive rent rich countries have Lionel Robbins: extracting versus uncertain meaning “both the concept of “creative” activities world money income and of national Increasing % of money income have � Annual or quarterly income devoted to strict significance changes are crucial housing house only for monetary guide to inflation prices increase: theory” targeting and inflation or real economic stabilisation income? 27
Four clear policy implications � Maximise stability and minimise downsides • Financial regulation and macro-economic management • Climate change mitigation � Maximise public choice: especially at local level � Minimise positional goods competition • Welcome population stabilisation 28
Growth in UK living standards: with 80% emissions cut GDP per capita 2006=100 300 338 1.0 – 2.0% 225 lower 150 100 75 0 2006 2020 2030 2040 2050 Business as usual 80% emissions cut 29
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