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Why macro-economists never win the Nobel prize
peterbirks
Alvin Roth and Lloyd Shapley have won the Nobel Prize for economics. It's another kind of gane-theory award. You might as well award the Nobel prize for economics for showing the optimal strategy with two draws to come and a Kxxx badugi against one opponent who is drawing one.

Macroeconomists don't win Nobel prizes these days. One reason is that they don't deserve them. When our brightest examples are the guys at the IMF (predictive capability with reality, negative. I.E., even if they'd picked things at random they would have done better), the Fed and the BoE, it's hardly surprising that the heirs of Nobel say "Thanks, but no thanks".

But there's another reason. That is that any macroeconomist who said stuff that merited a Nobel prize for economics would have to say stuff that was so unpopular that he would be sacked by his employers.

Let's take a hypothetical case for winning the Nobel Prize in a macroeconomic field -- one that provides the best way out of this current mess.

That solution would be one where everyone is a bit worse off, but where the sum of worse-offness is minimized.

Interestingly, this highlights an area where the Nobel Prize has already been won -- Prosepct Theory by Kahneman and Tversky. And it indicates why no macrtoeconomist can win when times are bad.

We all know how Kahneman and Tversky illustrated how irrational we are when it comes to economics. The easiest example is that of how people can be nudged in the direction of a 'risky' option or a 'safe' option, even though the gamble is the same, by the way the question is framed.

Put simply, if people pay $10 for a ticket, and are then offered either a guaranteed $15 or a 50% chance of $20 and a 50% chance of $10, a majority will choose the "guaranteed" $15. The EV gain is $5 either way.

However, if they pay $10 for the ticket and are then offered either a guaranteed $5 or a 50% chance of nothing and a 50% chance of getting their money back, most will take the gamble. The EV loss is $5 either way.

Another example would be a theoretical battle. You ask people "You can save these 300 out of a thousand for sure (show them pictures of mothers and babies and a few blokes) or you can risk these people dying along with the other 700, with a 30% chance that all 1000 will survive."

Usually people take the "certain 300" option.

But if you show people the "other 700" women and children and a few blokes, and say "If these people die, 300 other people will live. Do you want to let them die or do you want to take a 30% chance that all 1000 will survive?" then most people take the "I'll risk it" option.

At the moment the world is prepared to go for a 5% chance that they will get their money back and a 95% that they will lose 80% of their wealth (through war or political upheaval) rather than take the better EV of, say 70% of their money back for sure. Society as a whole cannot work together to split up a smaller cake. Individual governments are incapable of it. Supra-national organizations are incapable of imposing it.

So, if a macroeconomist today said "this is the best solution and this is how you calculate it", no-one would give that macroeconomist a prize, because it would entail accepting the "certain" loss that, as Kahneman and Tversky showed, individuals (and, in spades, whole societies) are incapable of accepting.

Indeed, the powers that be simply cannot accept the "smaller cake" argument or, if they do, they cannot accept who should make the sacrifice. The only certainty is that it should be someone else, because either it is that someone else's fault, or it isn't fair, or it would mean that promises would be broken.

The "best" way to divide up the smaller cake is, of course, by stealth. That's why the "German solution" for Greece and Spain is so wrong and, well, just isn't working. By contrast, the "slow inflation" method in the UK and in the US is, for the moment, working quite well. The distribution of the sacrifice is, of course, horribly random in places and is usually unjust. People already retired who are on final salary schemes are big winners. Those on fixed incomes, or about to buy an annuity, are big losers. Those who took out variable mortgages in the early 2000s are in clover (provided they aren't taking this benefit for granted and are just living off the unjust gains, which they probably are). Indeed, the long-term low-interest rate environment is causing a huge redistribution in proportional wealth (although not so great in terms of absolute wealth, because as a nation we are not getting better off) that the beneficiaries are taking for granted and the sufferers are complaining about bitterly.

Of such "solutions", Nobel Prizes are not won.

What would be the most "efficient" redistribution? Clearly, it would be the one that maximized economic output, not the one that maximized consumer (or voter) happiness. That would be a solution that encouraged economic activity and which penalized voluntary leaving of the marketplace. In other words, not a great deal different from what is currently happening. Make it so people can't afford to retire. Try to improve worker efficiency. Add in a few other things as well, such as stopping capital outflows in order to increase the size of the domestic multiplier (I recommend cutting income tax but paying the additional funds in a new second "domestic only" currency that would run in parallel with sterling, but which would not be accepted by the BoE as an internationally tradable currency and which could not be spent on imported goods. A blackmarket rate would soon evolve, but that would be fine).

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The scuppering of the EADS/BAE merger by the Germans highlighted something interesting. For all their talk of increased federalism and a more closely united Europe, the Germans seemed mysteriously unkeen on this example of greater unity.

Why? Because the Germans aren't at all keen on greater federalism when they have to take orders from elsewhere. They would only accept this merger if the new company was based in Germany - in other words, if the newly merged operation could be kept firmly under the German thumb. We have seen examples of this before, many times, when it comes to things like "free movement of labour". But it does kind of indicate how hollow and false is the talk from German politicians about a united Europe in any way shape or form, or indeed German criticism when the UK starts standing up for itself.

I used to be one of the great Europhiles. Culturally, I still am. But 1974 was a different era. Europe as it now is, the EU as it has now become, simply isn't working. I can see why British business, on the whole, wants to stay in. Not least because there's a good supply of labour that wouldn't be available to British business if we left. Perhaps that might not be a bad thing -- an increase in the cost of labour capital encourages mechanical innovation.

But the concept of "Europe" and what it aims to do has changed beyond belief in the past 30 years, and at the moment it's seriously beginning to look like little more than a front for German political domination by economic stealth. Its blocking of anything that might leave it in a minority (see EADS/BAE) shows that this Europeanization is not so much a matter of principle as one of convenience. "Yes, we want it to happen, but only on our own terms". That, in a way, is what the UK is saying. So what is it that makes us the baddies and them the goodies? Simple, control of the thought process and political processes in Brussels.

And here there is a big test, because Draghi is, in his own way, causing a bit of a revolution here. A system which the Germans put together, which they thought they could control, is turning against them. The Bundesbank and the ECB are, for the first time, firmly on opposite sides of the fence. If my theory is correct, that should spell eventual doom for Draghi as the Bundesbank finds a way to reassert control. If my theory is wrong, then Draghi's line will win and the Bundesbank will back down. That would mean Germany attempting to rewrite its constitution (the inflation bit) -- something that the German people might not permit.

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Pete, You say "People already retired (my italics) who are on final salary schemes are big winners. Those on fixed incomes, or about to buy an annuity, are big losers".

I don't follow. Once past the point of retirement., those (who were) on final salary schemes are then on fixed incomes - although sometimes with modest below-inflation adjustment.

Good point. An example of what happens when you type stream of consciousness and do not go over what you typed with a fine toothcomb; because, of course, it's easy to get lost.

To explain the source of the contradiction. I was actually writing about two different things, and failed to spot this.

1) Those who have retired on final salary schemes (many of whom do indeed receive an indexed increase every year) are almost certainly getting more out of the economy than their rentier status is generating in their pension funds. They are, therefore, net winners. If their pension funds were accumulating extra cash, and disbursing this elsewhere (e.g, if the companies operating them took pension holidays) then retired final salary scheme members would be net losers.

In addition, inflation is currently staying low (but higher than interest rate returns which are being artificially suppressed by QE) so the "absolute loss" to retired final salary scheme members (and indeed to those who bought annuities a few years ago) is less than for other members of society.

Finally, this is income without economic production. It's theoretically possible (and, in many cases, such as retired police officers, army generals, etc) to become economically productive while still cushioned with retirement income.

2) However, those on fixed incomes with assets are likely to be "big losers" over the next 10 years if and when QE has the effect of reducing the value of money. Here, the "big winners' will be those with no net assets at all or those with long-term debts fixed to the base rate. Real interest rates are likely to be negative for these people. meanwhile, QE continues to support asset prices.

PJ

"Make it so people can't afford to retire. Try to improve worker efficiency."

The only way those are compatible would be with significant absolute economic growth, wouldn't it? I'd say a lot of theoretical retirees would be seeking to postpone annuity purchase right now (and probably for several years into the future) but what do they do instead? Stay in work? Without growth there aren't any extra jobs, so youth unemployment goes up. Improving efficiency surely contributes to the problem if fewer workers are needed to get a constrained amount of work done. Or is this tied in with the QE/inflation idea: create the need for more work by stimulation?

I must say I'm glad I'm not ready for retirement age yet - I don't think I could afford it if I was.

Blimey Mike, considering how much the investment banks have taken out of the real economy without, as far as I can see, giving much back, you must have spent one hell of a lot of that unearned income (I'm not saying that you didn't earn it, merely that your bank paid itself, and, therefore, you, out of "profits" that were not genuinely created wealth, meaning that you were paid a bonus on wealth that was fictional) in the past decade if you aren't ready to retire. And, yes, I do include your bank in this -- that $5bn or so that it got from the US government in 2009 over AIG's 100 cents on the dollar basically just came from the printing presses. In genuine terms it should have been about 40 cents on the dollar.

On your previous point. Yes, you are in part correct; it would mainly be compatible with absolute economic growth. Good point.

However, there are caveats. The first is that improving efficiency should lead to greater economic wealth, although this might be hard to measure. The second is that it's easier to create jobs for unemployed youngsters (they are cheaper for a start) than it is to get older people back into the world of economic productivity. So I'm not saying keep someone old in a job in exchange for keeping someone young out of a job. I am, indceed, saying keep a greater proportion of the workforce economically active.

However, if you don't, there are "hidden" economic benefits -- just as in wartime (and this is a kind of war). One is that young unemployed tend to postpone having a family, and having a family is a big drain on a country's economy. If old people retire and their jobs go to younger people, you get a higher proportion of "economic dependents" (because those younger people will marry and have kids) than if you keep older people in jobs and economically force younger people to postpone their breeding.

Unpleasant facts (I told you macroeconomists wouldn't win the Nobel Prize) but we've seen evidence of this in the past.

PJ


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