May 24 2011

On Inside Job, offshore, and “descriptively false” economics

Posted by: Nick Shaxson in: Thoughts

John Kay, a leading Financial Times commentator, who has been speaking at the Institute for New Economic Thinking (INET) made this observation:

There is a moment in Brecht’s play Galileo where the Inquisitors refuse to look through Galileo’s telescope, on the grounds that the church has decreed that what he sees can’t be there. And actually if I think about the way some of the economists who believe in the theory of rational expectations in the last few years, I am often reminded of the inquisitors.

This is nice, though not exactly earth-shattering: the entire economics profession has been widely (and rightly) savaged since the onset of the financial crisis in 2007. I am driven to write about this now because I have just (finally) watched the superb, must-see movie Inside Job, about some of the things that caused the crisis – not least the appalling role of the economics profession in helping let all this stuff slide.

In particular I like this section of an interview with Professor Frederic Mishkin, a former governor of the U.S. Federal Reserve, who was asked about why there had been so little follow-up after dodgy loan documentation was brought to their attention in meetings. I think I’ve transcribed his response accurately here:

So, er, again, I, I don’t know the details in terms of, er, of, um, tsk, er, in fact I, I, just d-don’t, er, I, I, er, whatever information he provided I’m not sure exactly, er, it’s, it’s actually, er, to be honest with you I can’t remember this, this kind of discussion but certainly there were issues that were coming up.

This may seem like a cheap shot – but sometimes it’s only when you get to moments like this that you know that the interviewee has been well and truly skewered. Sony Pictures provides a video clip of him being skewered in another way, here.

Glenn Hubbard, former chief economic adviser to the George W. Bush administration and a key advocate of financial deregulation, was also interviewed just as memorably. The narrator asks him why, from his resumé, most of his outside activities involved consulting and directorship arrangements with the financial services industry, and wondered whether there had been conflicts of interest with his public and academic roles.

Narrator: who are your consulting clients?

Hubbard: I don’t believe I have to discuss that with you

Narrator: Okay.

Hubbard: In fact you have a few more minutes and the interview is over.

Narrator: Do they include other financial services firms?

Hubbard: Possibly.

Narrator: You don’t remember?

Hubbard: This isn’t a deposition, sir. I was polite enough to give you time. Foolishly, I now see. But you have three more minutes. Give it your best shot (snarls).

If you haven’t seen Inside Job, do so.

I’m also currently reading the book Econned by Yves Smith, which looks (among many other things) in more forensic detail some of the canards that underpinned deregulation and the onwards march to crisis. Here are one or two tidbits:

  • p24 – How the maverick economist Dani Rodrik unpicked research cite by Federal Reserve chairman Ben Bernanke, claiming that eliminating all trade barriers would increase U.S. household incomes by up to 10.1% of GDP. He recalculated using the same data and found the most generous numbers to be 0.25%, and cited another paper (see Table 2) suggesting the gains would be just 0.1% of GDP by 2015.
  • p28 Nice quote, following an analysis of how financial and other firms have captured policymaking: “In other words, ‘Free markets’ ideology, with its libertarian idealism, has in fact produced Mussolini-style corporatism. And until we learn to call the resulting looting by its proper name, it is certain to continue.” (This reminds me of Barry Ritholtz’ recent blog The Left Right Paradigm is Over: Its You vs. Corporations, or this thoughtful (if slightly wordy) article from Golem XIV on the European bailouts: “The division isn’t between nation and nation but between the banks and the people of every nation.” I argue in Treasure Islands, of course, that tax havens are central, malign players in this whole arena.
  • p29 Another lovely quote, from Yogi Berra, which is exquisitely appropriate for the economics profession: “In theory, there is no difference between theory and practice. In practice there is.”
  • Seventy years ago, economics was highly narrative and descriptive, with few tables and equations. Now it is chock full of them. (and it is still a crock of  . . . )
  • p47 An amazing quote from Milton Friedman, a high priest of the libertarians: “To be important, therefore, a hypothesis must be descriptively false in its assumptions; it takes account of, and accounts for, none of the many other attendant circumstances.” That is a real Friedman quote (though the Econned version differs slightly from others I looked up). From this kind of thinking flows all sorts of possibilities, such as assuming away the existence of crime or secrecy, or whatever. More on this just now.

These are just some whimsical bits I happened to notice as I read Econned.

Anyway . . . anyway . . . what’s all this got to do with Treasure Islands? Well, I’m going to use this context to discuss a recent presentation by my old friend Dan Mitchell of the Center for Freedom and Prosperity (one of Milton Friedman’s favourite institutions, it seems), talking to a bunch of tax haven folk in Bermuda.  Taking swipes at Treasure Islands, (following Treasure Islands having taken a colossal swing at him) Mitchell says a lot of things – most of which I dispose of here — so I just wanted to concentrate on one. Mitchell is reported as saying:

“most of the statistics relied upon by the critics in their arguments against IFCs were “make believe” numbers and unveiled where some of the more dubious figures came from.”

I don’t have a copy of his presentation, but here we get right back into the failings of the economics profession.

Let’s discuss one of the biggest numbers Treasure Islands cites, which is Global Financial Integrity’s recent research, updating stuff I cite in Treasure Islands, estimating illicit financial flows out of developing countries at US$1.2 trillion (yes, trillion) in 2008 alone – ten times the value of foreign aid flowing the other way.

How accurate is it? One economist in Washington told me he couldn’t take such a number seriously because “it is just too big.” (He didn’t have any particular issues with the methodology, however.)

Well, let’s start with some obvious things. It’s extremely hard to measure secret, illicit things, so GFI have to take a roundabout route. The research, led by former IMF Senior Economist Dev Kar, is quite involved, but it does note that these numbers aren’t so far off (very different) World Bank research which found that ‘capital flight” from developing countries in 1992 (yes, 1992, and I’ll talk about this later) amounted to US377bn. Adjust that for inflation, and we’re getting there.

But why go all the way back to 1992? Because the World Bank, for one reason or another, seems to have stopped measuring this stuff. This blog provides a picture of the World Bank’s latest research on this data. (Really, take a look at it – it won’t take 10 seconds to get the drift) From discussions in Washington recently, I discovered that the World Bank has put out an instruction to its staff not even to cite the GFI numbers. I know that there are certain people there – such as Peter Reuter – who are briefing aggressively against this research. Why? I don’t know. But this blog, citing Jack Blum being briefed against, aggressively, by the IMF, gives some pointers. (It would be mischievous of me to mention Galileo’s inquisitors again here, but hey, I will anyway.)

In Treasure Islands I note that GFI’s numbers for illicit flows from Angola constituted just nine percent of the value of exports in those years – and conclude, based on many, many years of having lived in and/or reported from that troubled country, that the GFI numbers simply have to be a gross under-estimate. (Tell any Angolan that just nine percent of their country’s wealth is being looted and sent offshore, and they will choke on their Robusta coffee. If you know any Angolans, try it.)

Economists will so often sniff at research such as GFI’s because you can never – nobody will ever – nail down these numbers exactly. And because they can’t nail it down exactly, they won’t discuss it. And people like Dan Mitchell will continue to call them “myths.”

Will this change? World Bank President Robert Zoellick, in a refreshingly frank appraisal of the post-crisis world, had this to say:

Too often research economists seem not to start with the key knowledge gaps facing development practitioners, but rather search for questions they can answer with the industry’s currently favorite tools.

Tax havens, along with many other nasties, have systematically been assumed out of existence by almost the entire economics profession. Go back and look again at Friedman’s “descriptively false” quote, to get a sense of it.

Finally, I am heartened by this quote of JK Galbraith:

All successful revolutions are the kicking in of a rotten door

And if there ever were a rotten door, offshore is it . . .

I leave you, following this slightly rambling blog, with this picture.

(If you don’t understand it, you didn’t click on that link I urged you to . . . )

Postcript: I’m glad to see now that Mishkin’s home page now has “Disclousure (sic) of Outside Compensated Activities” in big bold letters – though if you click through, it doesn’t exactly tell you very much about who paid him what fees for consultancy and speeches.

2 comments so far

Demetrius 5th May, 2011 1.24 pm

I have suggested that we now have in the UK and other places, The Taxable Economy, The Alternative Economy and The Illegal Economy. The first is in decline, the second increasing and the third also increasing, but more rapidly. As things stand these trends will continue until the Taxable Economy can no longer function.

[…] to a quote by the economist J.K. Galbraith: All successful revolutions are the kicking in of a rotten […]

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