RADICAL UNCERTAINTY

3 August 2024

ECONOMICS BACK IN THE DRIVING SEAT

Book review: Lord Mervyn King, former Governor of the Bank of England

"Radical Uncertainty: Decision Making Beyond the Numbers"

“Hope for the best but prepare for the worst”

Economics is about helping people make better decisions in the real world for themselves, for their businesses, for government, but what has happened over the last few decades as the discipline of economics has matured is that it has withdrawn into itself, rather losing contact with the real world and all its uncertainties. It has become dominated by model-makers and group think – problem being, the models are not a literal description of the real world, the real world it far more complex meaning we should be far less certain of our ability to manage change in it; and groupthink works by pressuring dissenters to accept the majority view*.

The world has become such a complex place with the result that the politicians have a tendency to outsource the problem to experts who, because they rely on their models, which can be faulty and inevitably do not include all available information, inevitably get it wrong. 

The result is a lack of confidence and cynicism on the part of the electorate towards the plans of their once- omnipotent leaders. Eg covid, Brexit, climate change – the experts delivered us advice based on false argument.

What governments (and ourselves) should do is to pay off the debt, live within our means and improve our productivity. The profligate behaviour of the government has ruined the country and by its bad example, led the people astray. QE was only ever intended to deal with one-off emergencies such as war or a pandemic, but it became part of the national economic framework because of the slow growth of economies. 

This created the problem that those who started with assets did well out of it, but those who had none like the young, did not. Plus now we have burdened our young people with a terrible national debt that they will have to pay off. And we make them borrow to pay for their education on which the future prosperity of the country is based. With the result that they are delaying forming a family because of this absence of funds and the uncertainty. The situation is exacerbated by migration, justified on demographic and liberal grounds, into Europe from Africa, setting up employment and infrastructure pressures, as well as pressures on the home culture, provoking a citizens' revolt and losing the awareness of all citizens belonging to one country or projecting one unified face to the world.

Demographics means more resources are needed by the state, in the form of taxes, to care for the elderly and integrate substantial immigrant population, while at the same time, fewer young people suggests less resources needed for education on which future prosperity is based. 

How are all these demands on the state to be paid for? You cannot increase the marginal tax rate on the wealthy without disincentivising wealth creation, yet general tax increases or austerity would not be popular at the urns. The problem today is that growing expectations of the people have, over time, meant that the state has grown larger and larger, until now that its part in overall economy is so large, it is very difficult to pay for the demands.

There are so many policy areas that need really radical change and yet our leaders, who may be  honest and intelligent, have the greatest difficulty in proposing a radical level of change to the electorate. The fundamental problem here is that if you increase investment, you must decrease consumption - consumption by individuals as well as by government.

Plus there is the question of unfunded liabilities such as future pension payments not backed from the social security fund - in other words commitment outside the national debt that will fall due and need to be paid in the future. Unfunded liabilities are not something people understand, but if this were explained, they would quite probably be prepared to tackle the problem. This requires politicians who are honest enough to explain and discuss this with the people in order to get the electorate behind the radical thinking needed to find a solution. The trouble is that this won’t work in a democracy where candidates must compete for votes - no one likes bad news, so the subjects that are difficult are skirted, the can is kicked down the road for the next government.

We are looking at a problem here with democracy itself. Imagine if a group of students in China went to see president Xi and said we want more democracy. He might very well reply, well do you want democracy like in America, where 30,000 people in a few swing states decides the composition of the electoral college and the future for everyone? 

Do you want democracy like in the UK where on a low turnout a party that won 14% of the vote got four seats, a party that got 34% of the vote got 64% of the seats? Or democracy like in France, where parties can gang up on the most popular and win the majority of seats? 

Democracies these days are seen by the people as arrangements where leaders game the systems for their own private or party advantage. We need to recognise that we are a fragmented society, two parties do not cover the diversity of interests and views. Moving to a multi-party world, proportional representation, PR, would capture that plurality of views in parliament and assemble a more representative democracy. 

Direct democracy would be a step further, with referendums (in a typical year, Switzerland will hold four referendums) and perhaps voting off your phone, taking the protests off the streets.

This makes it difficult to counter the argument that one strong party making decisions for the long-term isn’t more effective. We don’t deliver anymore, that is the trouble with our system and as they say "bad times make strong leaders" or at the very least require courage and wisdom.

Shouldn’t we be very worried that a group of Western leaders provoke Russia into a war that the people don’t want and the West is losing, or where tens of thousands of mainly women and children are massacred in order to protect an apartheid state, losing support from the “global majority”, or threats of war or disloyal competition with China, Iran, assist in a conflagration in the Middle East?

Surely we have to say to the people that we cannot do everything that you ask and the people will respect that if we are straight with them. Competence is a minimum requirement of our leadership and without explanations, solutions and competent execution, there will be a loss of enthusiasm and particularly amongst the young, who will see a diminished future and want to leave the country for better opportunities elsewhere. 

They’ve had to fund their education and pay their living expenses, they face paying off the debt of their parents and rusk finding their own pension is not covered, and in rhe present where they are supposed to build their own nest, many have acquired skills for which there is less demand and are faced with property prices that are well out of reach. How can the young start a family, the next generation, in those circumstances? 

We need good leadership but we would do well to note that the protest vote, protest movements, do not generate good leaders - we need opportunities that excite people and from the participation of young people in exciting opportunities will flow a new leadership.

Defence of the realm is a problem. Guns or butter? People want butter these days. When people think about defence industries, they think about corruption and waste and inefficient procurement processes, more than they think about the need for defence of the country. The defence industry is not just about defence as such, it is also - and this includes space - about massive innovation and technological advance.  Europe - and this includes the UK - has cut back on spending on the basis of the Peace Dividend and has relied on American supply for its lower unit costs and interoperability. The last World War left us victorious but bankrupt and we have never really accepted the proposition that we should be prepared for war to happen again. The evidence is in the poor support the West has been able to offer Ukraine. Defense budgets need to be increased and the European defence industry re-organised for home independence, shared standards and volume production.

Just consider the 1930s as a time when people could see the growing threat from Germany but were unwilling to commit to the trenches. There was the 1933 pledge. There was the amazing story of Britain’s strength of will in rebuilding its Air Force and so perhaps there was something to be said for Chamberlain giving us time to rebuild. You can see that defence in those circumstances meant going without and rationing in other words a cut back in consumption in favour of rearmament. As in Finland today. 

Also worthy of note that young people are looking for a cause and they found it in the defence of the country at that time and yet today the causes they find are often not very salutary. Offer young people a wholesome cause and they will participate, and a competent leadership will flow from this. But they need something to believe in.

The trouble is that the world is a complex place and we are often in situations without a precedent - at least not in our lifetime - and yet we think that we can model all this and optimise a solution in a spreadsheet and come up with a forecast and an answer. We think we can optimise, we think we can identify and mitigate all the risks and achieve our objectives, but rational decision-making needs a certain humility and admission that we do not know it all because the future is unknowable and that rather than pretending we can optimise, we should build resilience for the unknown, find solutions that are good enough, solutions that will avoid the worst while trying to make things better, rather than the best. 

The title of the book (summarised here and also turned aside with my own personal comment) sums up this dilemma between the need for radical change in times of maximum uncertainty. We should not let the best be the enemy of the good, we should take advice from good people and hope to do our best. "Hope for the best but prepare for the worst". So life is very complicated and it is critical to have the right people in place, able to make the right judgements and not simply to rely on models and spreadsheets and data and optimising on scenarios predicted by the system or “the experts”.

Central banks are having a tough time at the moment having made major policy mistakes. Covid meant shutting down the supply side of the economy and it was not a good idea to then print a heap of money, floor interest rates and boost demand. The result was inflation. Central banks eventually responded by raising interests and this seems to be working bringing inflation back towards target, allowing interest rates to slacken now in what could possibly be a soft landing.

As to climate change, if we cannot get covid right, then how can we possibly be expected to model long-term effects of climate change? But the point is that this does not mean we should do nothing - it means that we should take sensible steps to limit or mitigate the effects. 

But we are not going about this in the right way. Globally we should prioritise those countries responsible for the major part of emissions, but instead each country, each nation state has set its own net zero target and within each country, instead of asking all companies to reach net zero, we should accept that some Industries will be net positive and others net negative. We could manage this by having a carbon tax and favouring certain Industries whilst penalising others. A carbon tax should be global with some adjustment for imports and exports, but instead we are just exporting our carbon producing industry to manufacturing often poorer countries. Despite all the conferences, the consumption of fossil fuels is rising and rising dramatically. This is a matter for competence and integrity and thoughtfulness. Natural gas was Europe’s and the environment's main advantage but it has become a political issue.

Turning now to international trade and troubles with China. The progress since the last war and certainly since the 1970s has been made on cheap energy from Russia minerals from exploited smaller states, cheap labour from China and what was called the third world and America’s global institutions. Some have characterized this as America's neocolonial Empire.

This lifted billions literally billions out of poverty. But now, we have Trump threatening sanctions and tariffs of 10% on all imports into America. As we’ve been saying for a long time, China needs to rebalance its economy away from manufacturing goods for export,  that some are able to argue is flooding the world and threatening the Industries of more developed economies. And should instead rebalance towards production for home consumption - there’s no point in flooding the world with goods or building empty houses and roads that go nowhere, because this is of no benefit to the Chinese population who do all the work, leaving the West particularly America running enormous trade deficits on money stored in the dollar as reliable reserve currency. 

While more global trade can benefit everyone, certain communities missed out when their industry was shifted to another economy where labour was cheaper,  leaving them with nothing and no future. There’s a lot of bad feeling and disillusionment created when people the jobs and income go overseas and see certain members of the community benefit from the globalisation bandwagon. These people - labelled as deplorable, forgotten or declassified - they read this correctly as being at their expense and to the benefit of global capitalism. Simply imposing sanctions and tariffs, or worse going to war to take out the competitors supply manufacturing base, is not the answer as this will eventually disadvantage the home population as well. Nobody wins in a war be it economic or military, certainly not these days. 

Better to create geopolitical links in which to share the problems and the Chinese may well be open to that, but it requires extraordinary leadership with the complication of Taiwan always being on the negotiating table.

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Adapted from Failed Predictions : https://youtu.be/gnGOFvzMO6I?si=O-bufRA6OADiz8R0

1. Introduction

- Authors: Lord Mervyn King, former Governor of the Bank of England, and John Kay, economist and journalist.

- Book Title: "Radical Uncertainty: Decision Making Beyond the Numbers".

2. Concept of Radical Uncertainty

- Definition: Radical uncertainty refers to situations where outcomes are unpredictable and can't be quantified with probabilities.

- Key Idea: Traditional models and economic theories often fail to address the complexities and unpredictable nature of real-world decision-making.

3. Critique of Current Decision-Making Models

- Flaws in Probability Models: The authors argue that reliance on probabilistic models can be misleading in dealing with genuine uncertainty.

- Real-world Examples: Case studies of financial crises, pandemics, and political events illustrate the limitations of conventional models.

4. Alternative Approach to Decision Making

- Narrative and Stories: Emphasises using stories and narratives to make sense of complex situations rather than relying solely on data and models.

- Judgement and Wisdom: Encourages the use of human judgement, experience, and wisdom in decision-making processes.

5. Practical Implications

- For Policymakers: Suggests that policymakers should be humble about their ability to predict the future and should prepare for a range of possible outcomes.

- For Businesses: Advises businesses to build resilience and flexibility rather than trying to predict every possible risk.

6. Conclusion

- Main Takeaway: The authors advocate for a broader and more pragmatic approach to decision making in the face of uncertainty, moving beyond the comfort of numbers and probabilities.

7. Reception and Impact

- Critical Acclaim: The book has been praised for its insightful analysis and practical relevance.

- Influence on Thought: It challenges conventional economic thinking and encourages a re-evaluation of how decisions are made in uncertain times.

Glossary of Terms

- Radical Uncertainty: Situations where future outcomes cannot be predicted or quantified.

- Probabilistic Models: Mathematical models that use probability to predict outcomes.

- Narrative: A spoken or written account of connected events; a story used to make sense of complex situations.

Notes

Groupthink and leadership. The term was coined by psychologist Irving Janis in 1972. He identified it by studying decision-making processes in high-stakes political scenarios, such as the Bay of Pigs invasion. Where would we be today if JFK had abandoned his leadership role and gone along with the thinking of his advisors?

Some references on voting reform

http://www.livingintheair.org/2024/07/the-irresistible-case-for-voting-reform.html 

http://www.livingintheair.org/2024/07/combining-proportional-representation.html

http://www.livingintheair.org/2024/07/case-for-electoral-reform.html

http://www.livingintheair.org/2024/07/direct-democracy-swiss-experience.html

http://www.livingintheair.org/2024/06/votesmart.html

http://www.livingintheair.org/2024/06/direct-democracy-swiss-experience.html