The insiders behind the crisis
Simon Johnson, the former chief economist at the IMF, has penned a marvellous article, The Quiet Coup, that is now making the rounds among policy makers and analysts. It discusses the crony capitalism that lies behind most nations’ financial crises (mainly in emerging markets and now in the US), and the difficulties in solving them. For us in India, it is a cautionary tale.
Tags: Simon Johnson, The Quiet Coup
April 4th, 2009 at 8:56 pm
What is amazing is this Monday morning quarterbacking that goes on after the horses have bolted. Where were these guys before the patient got sick?!!!
Having said that, I find Paul Krugman (NYTimes) columns noteworthy and also the brave attempt by Wired to present a sexy analysis (http://www.wired.com/techbiz/it/magazine/17-03/wp_quant?currentPage=1). For a contextual piece, read up http://www.portfolio.com/news-markets/national-news/portfolio/2008/11/11/The-End-of-Wall-Streets-Boom.
Reading your book, Nandan and liking it so far.
April 5th, 2009 at 10:57 pm
Back to socialism? Its working for europe.
June 3rd, 2009 at 6:29 pm
The Quiet Coup is simply a vision of the world that is outdated and inflexible. Johnson’s view is summed up in a post of his on September 22, 2008, on his blog baselinescenario. He writes: ”
We’ve been getting quite a few questions about our views on the big picture. Let me try to set this out clearly, in terms of where we are (September 27, 2008, early Saturday morning) and where we are heading … Even if the odds of success for Plan A are high (ask us again on Monday about that), it makes sense to plan for contingencies. And we really don’t want to repeat the experience of this week, in which the initial proposal is weak and has to catch up with economic and political realities in a hurry.”
In other words, speed of events is overtaking Johnson’s analysis. How else can we explain that the “experts” - government and non-government - had not seen the crisis coming, had not acted? Remember how in the advance of the tsunami in 2004 animals all around Indonesia, Thailand and Sri Lanka ran uphill well before the waves that killed 250,000 arrived? How come the people who control the financial decisions didn’t get discomforted out?
Johnson is part of this tradition of the past. In doing so, he makes misjudgments. For him, there is a predictable relationship between what you wanted and what you got; that international crises had beginning and, if managed well, ends. This is a consensus of elites. But it fails both tests of good science: they neither predict nor explain our world.
Johnson is as bewildered by the present as the home-owner is. Here lies the paradox: policies designed by him and his ilk designed to make us more prsperous instead make the world more perilous. He advocates minor adjustments to current policies, incremental changes to failing institutions such as the IMF: he writes in The Quiet Coup “But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out. No, the real concern of the fund’s senior staff, and the biggest obstacle to recovery, is almost invariably the politics of countries in crisis.”
Not a single original thought here. The problem is not complicated: in a revolutionary era, those who think dogmatically and not originally have a particular name: victims. In this sense, what Johnson is lacking is something more profound than just diminished imagination: it is an arrogance of one who does not believe there are limits to IMF’s intelligence. Reality check: what is needed is a constant alertness - even to discard old models for new ones when they don’t work.
As said: “In the degree that the image [of the world] is false, actually and philosophically false, no technicians, however proficient, can make the policy that is based on it sound.” Our image of the global economy, constructed by people we once thought we could rely upon for such work, is false, actually and philosophically false. It’s time to replace it with an image that actually works.
The economy is a complex system, not susceptible to explanations like “the problem is the with the national politics of the economies”. This is as common as the spherical cow (the prescription by the theoretician as to how to raise cows that produce more milk.” It is false.
What is needed instead is urgent, steady ceaseless reform and innovation so that 5 or 10 years from now we will have a revolutionary architecture of financial security.
Simply, the lesson from Johnson is that he is wrong. History is not data; the future is not output. While his axiom of “politics as the problem” is an ideal candidate for a source of perpetual Ph.D.’s, possibilities to explore this endless debate, it is not helpful in making sense of the world: lack of corruption/presence of good governance does not equal financial security.
Economic reality is replete with contingencies and system irrationalities. The world isn’t a math problem. These dynamic parts cannot be pushed to the side because Johnson and others want simple prescriptions for public consumption. We are in too much danger to pay the price for this sort of policy simplicity.
Believing Johnson, that “Many IMF programs “go off track” (a euphemism) precisely because the government can’t stay tough on erstwhile cronies, and the consequences are massive inflation or other disasters” should disqualify you immediately from a serious position in foreign policy.
Johnson exhorts that business behaviour “must change”. Perhaps he needs to change a little too. After all, Alan Greenspan admitted his model of the world was wrong. Will Johnson? Will he pay heed to the twenty-minute apology by Hayek for winning one of the first Nobel Prizes in economics? His 1974 lecture was titled “The Pretence of Knowledge” He wrote (adaptable to present time): “Economists are at this moment called upon to say how to extricate the free world from the serious threat of accelerating inflation, which, it must be admitted, has been brought about by policies which the majority of economists recommended and even urged governments to pursue. We have indeed at the moment little cause for pride: as a profession we have made a mess of things … There is much reason to be apprehensive about the long-run dangers created in a much wider field by the uncritical acceptance of assertions which have the appearance of being scientific.”
Rather than being a craftsman shaping the handiwork that we view as the economy, perhaps it is time to rather cultivate growth by providing the appropriate environment, in the manner of a gardner and his plants. Johnson believes we are architects of a system we can control and manage; what if the truth is that rather we are gardners in a living, shifting, ecosystem?
Perhaps what we need is a little loss of certainty from the elites such as Johnson. Simply accepting that the economy is not as objective or deterministic as we’d like — nonlinear — is not enough. We need experts who are helpful in shaping the flow of this dynamic, complex system; one which may well be past its critical state. We need humbled, perplexed and worried masters.
What our economic world is today defined by is an increasing number of players (glanuarity) and the connections between them (interdependence). Simply saying that root out the bad banks is folly: it allows the physics of these real world processes to assert themselves. A complete lack of understanding that we are today organized into instability is what worries me. Johnson’s reading makes me more worried than ever. Rather, the need of the hour are those who accept the basic unpredictability of the global economic order - one of those intellectual leaps that sounds simple but immediately junks a great deal of traditional thinking.
The economy is not mechanistic. Subjects and objects cannot be neatly separated. Rather, it is organic; not a well-ordered giant machine, rather contains pockets of indeterminacy. Older tools to manage the economy to stable equilibrium are bound to fail.
But this does not mean total chaos either. Complex systems are not incomprehensible.
Two revolutionary books that are great reading on mastering the complex world: The Age of the Unthinkable and The Upside of Down.
Enjoyed reading Imagining India and your blog.
Best wishes.
July 3rd, 2009 at 9:12 pm
Somewhat late comments on a rather long post from DK… doubt they will be read by him but fwiw:
- why do we need the financial system to be so complex? yes, it is complex today but do we need it to be? Which benefits will be lose if CDS’s and CDOs are moved to exchanges (and regulated like other derivatives)? Which benefits will be lost if commercial and investment banking is separated?
- Nassim Taleb looks at it from another point of view. One of the ways a system can be made robust against black swans is to have enough redundancy in the system along with appropriate checks. What this means is excessive leverage just cannot be allowed. Again, what benefit do we lose by reducing leverage? You are misrepresenting the issue if you think that the issue is that the complex system is “incomprehensible”. Nope, thats not the problem, the problem is that the system is fragile and not resistant to extreme events and partly due to unnecessary complexity. Those are two different things.
- Dk makes a lot of comments on the economic order. Simon talks about the financial oligarchy. Those are two different things. Simon isn’t saying we go back to an old “economic” order. He’s talking about breaking the oligarchy so that appropriate reforms can occur.