The monstrous conceit of modern economics TheStar.com - Opinion - The monstrous conceit of modern economics January 02, 2009 Robert Skidelsky
After World War I, H.G. Wells wrote that a race was on between morality and destruction. Humanity had to abandon its warlike ways, Wells said, or technology would decimate it. Economic writing, however, conveyed a completely different world. Here technology was deservedly king, and morality should not seek to control it but, instead, should adapt to its demands. Only by doing so could economic growth be assured and poverty eliminated. Traditional morality faded away as technology multiplied productive power. Our faith in the market - for the market is the midwife of technological invention - was a result of this belief in technological salvation. In its name, we have embraced globalization, the widest possible extension of the market economy. Moralities that resist this logic are branded "obstacles to progress." Protection - the duty the strong owe to the weak - becomes "protectionism," an evil thing that breeds war and corruption. Likewise, theological language that might have decried the credit crunch as the "wages of sin," a comeuppance for prodigious profligacy, has become unusable. But consider the way in which the term "debt" (the original sin against God, with Satan as the great loan shark) has become "leverage," a metaphor from engineering that has turned the classical injunction against "getting into debt" into a virtual duty to be "highly leveraged." To be in debt feeds the double temptation of getting what we want as quickly as possible, as well as getting "something for nothing." Financial innovation has enlarged both temptations. Mathematical whiz kids developed new financial instruments, which, by promising to rob debt of its sting, broke down the barriers of prudence and self-restraint. By contrast, the virtuous Chinese, who save a large proportion of their incomes, were castigated by Western economists for their failure to understand that their duty to humanity was to spend. The key theoretical point in the transition to a debt-fuelled economy was the redefinition of uncertainty as risk. This was the main achievement of mathematical economics. Whereas guarding against uncertainty had traditionally been a moral issue, hedging against risk is a purely technical question. The main uncertainty in life - the destination of one's immortal soul - nudges one toward morality. Even the existence of mundane uncertainty gives rise to conventions and rules of thumb that embody the best of human experience in dealing with the unknown. The abolition of uncertainty abolishes the need for moral rules. Future events could now be decomposed into calculable risks, and strategies and instruments could be developed to satisfy the full range of "risk preferences." Moreover, because competition between financial intermediaries steadily drives down the "price of risk," the future became (in theory) virtually risk-free. This monstrous conceit of contemporary economics has brought the world to the edge of disaster. Obviously, the traditional moral taboos surrounding money had to be loosened for capitalism to get going centuries ago. For example, the classical prohibition on usury was softened from a ban on charging interest on all loans to a ban on charging interest on loans for which the lender had no alternative use, i.e., for charging interest on "hoards" or cash balances. Without the development of debt finance, the world would be a lot poorer than it is. Yet, going from one extreme (keeping spare cash under the bed) to the other (lending out money one does not have) is to cut out the sensible middle. The prudential supervision regime initiated by the Bank of Spain in response to the Spanish banking crises of the 1980s and 1990s proves that point. Spanish banks are required to increase their deposits in proportion to their lending and set aside capital against assets in their off-balance sheets. With little incentive to manufacture "structured investment vehicles," few Spanish banks created them, thereby avoiding excessive leverage. As a result, Spanish banks typically make provision to cover 150 per cent of bad debts whereas British banks cover only 80 to 100 per cent, and Spanish homebuyers must pay between 20 and 30 per cent as a down payment on a house, whereas 100 per cent mortgages have routinely been given in the United States and the United Kingdom in recent years. H.G. Wells was only partly right - the race between morality and destruction encompasses not just war, but economic life as well. As long as we rely on technical fixes to plug moral gaps and governments rush in with rescue packages that enable the merry-go-round to start up again, we are bound to keep lurching from frenzy to frenzy, punctuated by intervals of collapse. Robert Skidelsky is professor emeritus of political economy at Warwick University and author of a biography of the economist John Maynard Keynes.
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