"Feb 12 2009, 9:33 pm
Listen to Amar Bhidé
As Clive Crook and Arnold Kling remind us, even the most brilliant economists are not very good at settling basic questions over how the world works. To a greater extent than most of us would care to admit, we're relying on gut instincts, crude heuristics, and, yes, ideological biases. I'll be the first to admit that I have a favorite guru. When media outlets are looking for an optimistic, heterodox voice amidst the economic gloom, they are increasing turning to the extraordinary Amar Bhidé. The son of a successful entrepreneur who also happened to be a Stalinist and a bombmaker for pro-independence Indian terrorists, Bhidé sticks out like a sore thumb in the gray, colorless world of business punditry. He is also, in my view, the most brilliant and insightful economic thinker around, and he is the author of my favorite book of 2008 by far, The Venturesome Economy.
I was hoping to see Bhidé of Columbia Business School give a talk earlier today, but I had to miss it thanks to an ill-timed cold. Like Nicholas Nassim Taleb, author of The Black Swan, Bhidé is a critic of Bayesian thinking. He elaborated on this theme in a short piece on banking regulation that recently appeared in BusinessWeek.
Until the 1930s, economists had two views of uncertainty. John Maynard Keynes and Frank Knight (who then dominated the University of Chicago's economics department) treated uncertainties as elements that couldn't be quantified. Followers of the 18th century mathematician Reverend Thomas Bayes, on the other hand, quantified uncertainties as if they were bets placed on a roulette wheel.
In Bhidé's view, the triumph of the Bayesian view has lulled us into a false sense of security, one that has been shattered by recent events. Read the whole thing.
The focus of the book is, to quote the subtitle, "how innovation sustains prosperity in a more connected world." In the course of a detailed examination of how VC-baked businesses innovate, Bhidé outlines a framework for understanding how new ideas become successful new products. It turns out that cranking out scientists and engineers who perform basic research isn't the key to prosperity, a claim advanced by any number of economic Cassandras who fret over the supposed "threat" posed by the growth of R&D in China and India. Rather, mid-level and low-level innovations play a role that is at least as important. To get a good sense of Bhidé's brilliantly quirky take on the global economy, check out (if you can) The Economist's review, which I believe was written by veteran correspondent Vijay Vaitheeswaran.
First, [Bhidé] argues that the obsession with the number of doctorates and technical graduates is misplaced because the "high-level" inventions and ideas such boffins come up with travel easily across national borders. Even if China spends a fortune to train more scientists, it cannot prevent America from capitalising on their inventions with better business models.
That points to his next insight, that the commercialisation, diffusion and use of inventions is of more value to companies and societies than the initial bright spark. America's sophisticated marketing, distribution, sales and customer-service systems have long given it a decisive advantage over rivals, such as Japan in the 1980s, that began to catch up with its technological prowess. For America to retain this sort of edge, then, what the country needs is better MBAs, not more PhDs.
America also has another advantage: the extraordinary willingness of its consumers to try new things. Mr Bhidé insists that such "venturesome consumption" is a vital counterpart to the country's entrepreneurial business culture.
This last point strikes me as particularly important. Most graybeards tells us that American consumers have to change their spendthrift ways, and this is surely true to an extent -- but those spendthrift ways have, in Bhidé's view, been a source of American technological leadership, as he explained to Maria Bartiromo.
As we speak, people of middle to low incomes are buying iPhones, and they're buying them smart because they're buying them to use as substitutes for computers. Many macroeconomists just think of consumption as one big lump of stuff. In fact, it's a whole bunch of things, some of which are good for the economy in the long run and some of which are less good. So I think we'll see a cutback in the kinds of things people consider dispensable. They may eat out less. They may not trade up to a larger home. But history suggests there will be no cutback in the consumption of the kinds of new technologies and products that ultimately make the economy grow.
Bhidé's contrarianism doesn't end there. Though he's no reflexive nationalist, Bhidé remains confident in the resilience of the American economy. But he is also deeply skeptical about both the bank bailouts and the various stimulus proposals floated by right and left.
One of the few things I agree with Paul Krugman about is that competitiveness is a dubious notion. One can talk about competitiveness in the Olympics, but competitiveness in terms of economic growth puts things in completely the wrong frame. We are living a world where there is going to be, in the long run, more prosperity in more parts of the world. As prosperity increases in more parts of the world, the U.S. share of world GDP will decline, and that is a good thing. But in the next couple of years, we could completely mess this up and go in the direction of socialism. We could go crazy with these stimulus packages and destroy the free-enterprise ethos that has sustained innovation for the past several centuries. I would rather have a slower recovery than try to accelerate the process and destroy the foundations of the free-enterprise system.But like it or not, that's not an option that's on the table. "
Me:
From the FT:
http://blogs.ft.com/economistsforum/2009/01/putting-an-end-to-financial-crises/#more-315
"With the government ready to absorb losses, banks are talking outrageous risks knowing that Uncle Sam will cover them if things go south. Raising the trivially low capital requirements of banks, as Paul Volker’s Group of Thirty Commission just proposed, won’t change this behaviour.
What will change this behaviour is to not let it happen. Banks should be allowed to initiate only conforming, i.e., government-approved, AAA-rated mortgages and business loans. These would be long-term, fixed-rate loans with 20 per cent-down and payments below 25 per cent of income.
The government, via the Federal Financial Authority, would use tax records to verify loan payment-to-income ratios. It would also spot check collateral. Once approved, the banks would bundle and sell “their” loans within mutual funds.
Again, traditional bank runs wouldn’t arise. And today’s bank runs, which entail lenders and equity investors avoiding risky banks, wouldn’t either. Why? Because banks would bear zero risk. Mutual fund owners would bear risk, but not the banks. And these lenders would know they were buying government-approved AAA-rated loans, not Bear Stearns‘ CDOs.
This limited purpose banking is a modern version of narrow banking proposed by Frank Knight, Henry Simons, and Irving Fisher. Banks would hold deposits, cash checks, wire money, originate loans, and market mutual funds, including money market funds with no guarantee of par value redemption.
With limited purpose banking, financial crises would largely disappear. Banks would never fail, never stop originating loans, never expose the public to massive liabilities, and never see their stock values evaporate. Banks would be stable, boring economic cogs - like gas stations.
The Fed would also gain full control of the money supply. To expand the money supply, the Fed would continue buying treasuries from the public and supplying cash. But banks wouldn’t be multiplying and contracting M1 (cash plus demand deposits) based on their ever changing decisions about lending deposited funds.
Milton Friedman, who also advocated narrow banking, blamed the Depression on the Fed’s failure to offset the M1 money multiplier’s collapse. In the past year the M1 multiplier has contracted by over 40 per cent, forcing the Fed to double base money. If the multiplier shoots back up, we could see the money supply and prices explode.
What about investment banks, brokerage firms, hedge funds, and insurance companies? What’s their right financial order?
Again, regulate to purpose. Investment banks take companies public and assist in mergers and acquisitions. They shouldn’t be permitted to invest in their clients’ companies. Brokerage firms are here to help us buy and sell assets, not to gamble on spreads. Hedge funds are here to help limit risk exposure. They aren’t here to insure these risks themselves. Finally, insurance companies are here to diversify risk, not write insurance against aggregate shocks."
Now Bhide:
"A RADICAL IDEA, REVIVED
Here is my modest, quasi-libertarian, proposal: To prevent future meltdowns, let's revive the radical idea of narrow commercial banking. Let's tightly limit bank activity to taking deposits and making loans—loans that bankers and regulators who aren't theoretical mathematicians can monitor. (Simple hedging to reduce the risks of making long-term loans with short-term deposits would be allowed.)
Anyone else—investment banks, hedge funds, trusts—would be allowed to innovate and speculate, free of additional oversight. But they wouldn't be permitted to trade with or secure credit from regulated banks, except through prudent, well-secured loans. None of this would require new agencies or more regulators.
Such new limits might alarm those who claim the "sophistication" of our financial system is a prime source of U.S. prosperity. But while a modern economy needs financial basics—risk capital, credit, insurance—it's foolish to believe that the bells and whistles created in the past few decades have been a net plus. Does anyone really think the financial sector now receives more than 30% of domestic corporate profits—double its share 25 years ago—because it has made improvements of that magnitude in mobilizing or allocating capital? "
Even though I'm a follower of Fisher, I previously that this idea was too restrictive. But now, seeing the possible proposals, this idea seems worth considering, especially if it will allow another non-guaranteed part of our financial system that allows innovation. That's better than a system that stifles innovation, which many of the proposals will.
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