SUPPLY-SIDE BIAS AND
RATIONAL CHEATS: REFLECTIONS
ON THE STATUS OF POLITICAL ECONOMY AND
NEIGHBOURING DISCIPLINES IN THE WAKE OF
THE GREAT FINANCIAL CRISIS
Bent Sofus Tranøy
University of Oslo and Hedmark University College
Outline of the talk
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
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A brief history of supermodels
Supply side bias in political economy (and
economics)
VOC, LME-hood and financialization
Governing rational cheats and other closing
reflections
What is a supermodel?

A model economy that is fashionable for a while
Becomes example of ”best practice”
 Emulation => imperfect institutional isomorphism

Rises to prominence
Through goodness of fit with trends in the world economy. i.e ability
to utilize cheap and abundant resources


Perceived ability to solve problems that seem particularly
pertinent at any given moment in time

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Inflation, unemployment, export performance, innovation, female
participation combined with fertility
Indicates an ideational component:

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Untapped labour, “costless” dumping of pollutants, some raw material
The power to shape a discourse in game involving academics,
international technocrats, think-tanks, journalists
Any accumulation of knowledge?

Success factors at T0 morph into reasons for failure at T1
A brief history of supermodels I
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US Fordism
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French indicative planning
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Industrial miracle
Model Deutschland
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Ability to handle inflation/stagflation
Japanese Coordination
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Impressive growth and infrastructure achievements
Northern European Corporatism
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Masters of mass production
Combining hard currency with export performance
Flexible specialization
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Regional response to the crisis of mass production
A brief history of supermodels II
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Asian Tigers – export led growth
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Celtic Tiger

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Generalizing from Nokia?
Flexicurity – combining dynamic labour markets and social security
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Impressive growth performance, successful “hotel state” strategy
Finnish innovation (and education) miracle

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Late, but impressive growth spurts
Danish growth and employment performance
Dutch Miracle
Nordic Model

Trust, welfare, coordination and productivity
Flashpoint: Rhenish vs Anglo-Saxon
capitalism

The Albert position:
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Return fire: the US-”jobs machine” position

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Defending the longtermism and social embeddedness of the
Rhenish model
Always explained in micro-terms (flexibility), never macro
VOC adjudicates:
Two institutional equilibriums identified,
 Based on complex interplay between five subsystems:
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Inter-company relations,
Finance (or a market for corporate governance),
Industrial Relations,
Skills and training,
Intra-company authority relations
Supply side bias in political economy I
 We
have followed orthodox economics in focusing
on supply side matters
 Macro-issues got serious treatment last:

after the great crises of Norway, Sweden and Finland around
the turn of the decade, and the EMS/ERM turmoil in 1992-93
(Notermans, Moses, Andrews)
 Since
then, more or less nothing
 Look at the VOC-agenda above, not much macro
there
 Add to this:

Innovation systems, childcare and female participation rates
Supply side bias in political economy II

Historical irony
 Serial
bubble blowing
 Emerging
markets =>Dot.Com =>housing
 Gave
an appearance of strengthened state
finances
 And
allowed us to forget one bubble with the help of
the next one
 Financial
instability relegated to a development
concern at best
 Immature,
not deep enough markets, poor
governance etc
How could we (you guys actually) let this
happen?

Out of sight out of mind?
 Many
good things in life are only noticed when they are
gone

The influence of mainstream economics
Representative agents with rational expectations.
 Do not suffer from “money illusion”
 Leaves no room for positive fiscal action, avoiding inflation and/or
unemployment above the “natural rates” becomes the only macro
goal
 Correspondingly large potential for improving efficiency through
improving incentives and getting prices right

Supply side bias in financial economics

Efficient market hypothesis: All relevant info instantly
baked into prices:
 Financial
markets is a servant to the real economy
 Markets are self correcting
 Bubbles do not exist
*If they did it would violate either the rational expectations assumption
or the representative agent or both.
A tremendous asymmetry in terms of what to worry about was
created
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The next two slides show a a favourite example of
mine, OECD on Iceland

(special thanks to Herman Schwartz)
OECD take one
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The Icelandic economy is prosperous and flexible. With
its per-capita income growing at double the OECD rate
since the mid-1990s, it is now the fifth-highest among
member countries and more than a quarter above the
OECD average. This impressive performance is
attributable to extensive structural reforms that
deregulated and opened up the economy, thereby
unleashing entrepreneurial dynamism, as evidenced by an
aggressive expansion of Icelandic companies abroad.
OECD Economic Survey: Iceland, 2008, p. 11
OECD take two
•
•
Iceland has plunged into its deepest economic
recession in decades after succumbing to a
widespread financing crisis and a collapse of
domestic demand… While Iceland is in part a
victim of the international crisis, its severe plight
largely results from a recent history of ineffective
bank supervision, exceptionally aggressive banks and
inadequate macroeconomic policies.
OECD Economic Survey: Iceland, 2009, p. 9
VOC, and LME-hood

Received wisdom from VOC school:
Positive view of the effects of a given set of institutional
features of finance system
 Text-book economics with a dollop of institutionalist flavour :

Powerful incentives = incentives to work hard and achieve over the
short term
 Highly developed markets for venture capital supports radical
innovation
 Market based monitoring works
 Financial innovation is a good thing, supports innovation in the real
economy

Financialization – definition
’Financialization refers to the increasing importance of
financial markets, financial motives, financial institutions,
and financial elites in the operation of the economy and its
governing institutions, both at the national and international
level’ (Epstein 2001)
(this and several of the following slides are taken from
Ingrid Hjertaker, MA-student at the University of Oslo)
Financialization - indicators
Economic:
 The FIRE sector (Finance, Insurance and Real Estate)
has grown – measured in employment, as part of
GDP, and above all profits.
 Increase in rentier incomes also in non-financial
businesses
 Increase in household debt/income ratio
 Increase in both mortgages and unsecured consumer
debt
Indicators continued
Political:
 Lobby power: most notably in the US, but also on the
international level
 Ideational power - What’s good for Wall St is good for
the US or ’What’s good for the City is good for Britain’
Cultural:
 Changed status of the financial sector in society
 Example: Ivy League recruitment 1960 vs 2005
LME in light of financialization
unhinged I

Powerful incentives tend to corrupt
Abstract theft is easier on the mind than stealing actual money
 Self-justification bias and low risk of getting caught
 Cultural change?
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Market discipline and market based quality control
cannot be taken for granted
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Informational and transaction cost economics could have indicated
as much?
Atomistic ownership structure conducive to management
malfeasance

Coffee’s work on the Dot. Com crisis
LMEs in light of financialization
unhinged II

Key Wall Street/financial sector players are too
powerful
In politics
 Vis-a-vis regulatory bodies
 In the market place (Yves Smith and others on how the market was
played e.g.by stimulating issuance of paper to bet against


Financial innovation can lead to horrible results
The banal level: Securitization US-style decouples risk and
decision making
 “Rocket science” level: Models for estimating and pricing of risk

Financialization and the welfare state
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What are the links if any?
Let them eat credit

Positive intepretation:
a
’democratization’ of credit, extending opportunities
for material welfare and prosperity to new groups
previously excluded from credit markets

Negative interpretation:
 providing
the working and middle class expensive
credit in place of real wage increases
 exploiting the poor and financially illiterate for profit
The financial sector and the state
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The financial markets and the welfare state as alternative
mechanisms for welfare allocation
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The more extensive the welfare state the lesser the demand for financial
market services for insurance, savings and credit
Empirically this picture is more complex:
The degree of financialization varies across countries, but NOT
along common distinctions such as Esping-Andersen or the
Coordinated vs Liberal Market Economy dichotomy.
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The UK and US as the most financialized societies, but from there on it’s
tricky to fit other cases in these taxonomies
This represents a challenge to the comparative study of financialization
Financialization of the welfare state

The great risk shift – from governments and business
to individuals and families.
 The
defining economic transformation of our time
(Hacker)
 Broader trend: A shift from ’defined benefit’ to ’defined
contribution’ (Pensions above all)
 Payout subject to individual choice, market
developments, timing and luck
 Financialization
from within?
Approaches to instability – rational
cheats
Equilibrium
Disequilibrium
Rationality
Standard neo-classical
theory, + EMH
Agency problems, Going
for broke (moral hazard)
and going broke for profit
(tunneling)
Animal spirits
Stabilizing speculation,
”smart money” (Friedman)
Keynes; Minsky;
Kindleberger, Akerlof
&Shiller: Stories, confidence
multiplier, money illusion
Opportunistic Keynesianism

Intellectual underpinnings “secured” through temporary
application of animal spirits type theory of action
 “Wall

Note contrast to Asian crisis intellectual fall-out
 Crony

Street got drunk” (GWB)
capitalism
Structural explanation requires structural reform,
conjunctural explanation justifies Selective Keynesianism
Concluding remarks
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Learning (or lack thereof) in mainstream and technocratic
economics becomes a key issue
Structure vs conjuncture in Financial instability
One promising way of linking structure and conjuncture is
through the study of housing finance systems
Welfare researchers should look to the systemic effects on
the financial system of welfare reforms also
Link the good governance and financial regulation
agendas – when do incentives lead to cheating?