Assessment of Game Theory

At best, game theory predicts reality in the same way as “The Emperor’s New Clothes” predicts the future political path of Yair Lapid. (Israel's Minister of Finance)

How game theory will stop Iranian nukes
I've devoted most of my life to economic theory and game theory. I believe that I would like to do some good for humankind and, in particular, for the people of Israel.
by Ariel Rubinstein for Haaretz.
(via Steve Keen on Twitter).

Game theory is mentioned often in economic circles, to some extent it held out hope of making economics a science by replacing outdated and entirely erroneous assumptions about consumer behaviour. I'm very doubtful about the use of these hypothetical and abstract models for predicting real human behaviour.

Rubinstein, who has studied game theory for 40 years, confirms many of my suspicions:

Nearly every book on game theory begins with the sentence: “Game theory is relevant to ...” and is followed by an endless list of fields, such as nuclear strategy, financial markets, the world of butterflies and flowers, and intimate situations between men and women. Articles citing game theory as a source for resolving the world’s problems are frequently published in the daily press. But after nearly 40 years of engaging in this field, I have yet to encounter even a single application of game theory in my daily life. [my emphasis]

Like the use of quasi-medical Latin terminology in translations of Freud's vernacular German (e.g. ego for Ich) the fact that game theory is presented in formal mathematical language "creates an illusion that the theory is scientific."

"some have recently contended that the euro bloc crisis is like the games called Prisoner’s Dilemma, Chicken or Diner’s Dilemma. The crisis includes characteristics that are reminiscent of each of these situations. But such statements include nothing more profound than saying that the euro crisis is like a Greek tragedy."

Steve keen merely says "Realistic assessment." At the end of the article Rubinstein confesses that his first choice for a title for the article was "Why game theory doesn’t solve the problems of the euro bloc and won’t stop Iranian nukes" but he thought it might put people off.

What does "Economic Recovery" mean in the present.

The 2013 GDP estimates were out this week. 0.3% growth for the quarter is OK for an economy in crisis. Hardly a vindication of the coalition government's economic acumen, but it might have been worse. However the figure is historically low.  During the 1990's for example quarterly growth averaged about 0.65%.

The pattern of recessions in the past was that a relatively brief period of contraction was followed by above trend growth that returned the economy to trend. We can see this in NIESR's chart showing the path of recession and recovery in various previous downturns, updated for their estimate of monthly GDP, published March 12, 2013.

from Not the Treasury View

The black line is the present. What it looks like is that zero growth is the new trend. Indeed there was growth in the period 2009-2010 that looked like a recovery, but since then growth has averaged about 0.04%. With margins of error this is zero. Though I have yet to find a margin of error figure for GDP estimates, the figures are stated to the nearest 0.1% and anything less that that is probably noise.

And why is growth so low? Well it's widely acknowledged to be because demand is low - both consumer and business, in the UK and Europe. Now why demand is low is the subject of debate, but those economists who take note of levels of private debt point out that it is still high. Household and business debt are very high. Thus spending is low while people pay off their debts.

To be sure, other people are saving and have piles of cash or capital waiting to be invested. But while demand remains stubbornly low it doesn't make good business sense to invest. Because effectively what is meant by "investment" is an expansion of supply of goods and services. And when demand is low it is counter-intuitive to argue for increasing supply. So an investment led recovery is a non-starter.

Though of course the government have been banking on this for 3 years now. Indeed the government are keen to make the banks lend more. But with so much debt in the system, and the disastrous results from too much debt, the banks (newly sober) are reluctant to lend. Lending to business in a chronically depressed economy is a high-risk enterprise. So even with a great deal of carrot and stick government has failed to get banks to lend more. A debt led recovery is also a non-starter.

Ideally consumers would start to spend more and demand would rise and everyone would become optimistic and start investing again. But this is wishful thinking. Consumers as an aggregate have very high debt levels. What's more real wages are falling at present. So a consumer led recovery is also a non-starter.

What's left? There really is only one sector of the economy that can invest under the present conditions. That is the government. If the government continue to pursue austerity and make only token gestures towards investment then nothing is going to change. Indeed rather worryingly the reduction of debt stopped in 2012. Debt levels in the private sector remained static at 440% of GDP.

So the way things are looking zero growth will be the new trend. Some people have described this as a plateau, but really this is a valley floor - we're still below the peak of 2008. And we're bumping along the bottom. Present government ideology driven economic policy is now widely perceived outside the Treasury to be harming the economy. Even that bastion of monetarism, the IMF, is having second thoughts about the austerity that has crippled Europe and the UK. While the mainstream continue to ignore the role of private debt in the economy nothing much will change.

Steve Keen at INET

Professor Steve Keen recently spoke at the INET conference. It was a short talk, but full of his usual gems. His talk starts at 20.45 (I can't seem to embed with a time reference).

Notable quotes

"Workers pay for higher [private sector] debt via a lower shares of wages."

"Inequality leads to economic collapse"

"The most important driving force in a capitalist economy is private debt."

Spending vs Investing - updated

There seems to be some confusion amongst people who comment on news articles online and politicians about the distinction between spending and investing. Thus when the people say things like "So in a nutshell, what will you do? Spend or not spend?" it completely overlooks the other possibility.

We spend money when we get what we pay for and nothing much else. However the govt is in the enviable position of getting multipliers. As it spends money on welfare, those receiving the payments spend almost all their welfare in the real economy - on rent, food and basic services. This helps to keep money flowing through the economy - like cash flow in a business. And since tax is paid on what is earned and spent a lot of what they spend comes right back to government, to go through the system again.

Investing is a totally different proposition. If I invest in building a house I pay the money up front but then I sell the house at a profit once it's built. Building houses in the UK is very profitable because houses sell for about 5x what they cost to build. You spend £50,000 and sell the house for £250,000. This is the essence of capitalism - investing capital in order to make a profit. And that £50,000 is also spent - so a lot of it goes through the same cycle as other spending and comes back to the govt as taxes.

The IMF have confirmed that the major contribution to government borrowing at present is reduced revenue due to the depression. Demand for goods and services has dropped off dramatically so that the economy is now hovering around zero growth (with a few ups and downs). Thus tax revenues have fallen off and the government has spending commitments which it must meet by borrowing.

The present government has a strong ideological commitment to allowing the real economy ('the market') to take care of themselves and to reduce spending by making cuts. They have made minimal attempts to encourage lending for investment but these seem to have been in ignorance of the massive debts held by the private sector (despite this information coming from government Budget Reports - esp 2011 and 2013).

The other option, the one that the Chancellor had built his hopes on was that part of the private sector is sitting on a large surplus. This surplus capital is of a scale that if it was invested it would stimulate the UK economy. However while demand is low investors are rationally and understandably reluctant to risk their capital, and more or less unable to borrow to invest as banks see the same economic conditions as making loans risky (this is aside from the fact that the banks created this problem by lending too much money in the first place).

In addition the government's austerity policies (again according to the IMF) are depressing demand in the short term. While demand is low the private sector cannot (because of too much debt) or will not (because of too much risk) invest in the UK economy and we stagnate. And this will simply go on until the levels of debt fall low enough to make an impact on demand. No one knows how long this will take. The March figures from the ONS show that household and private sector deleveraging is more or less stagnant - we stopped paying off debts in 2012. So the process could take a very long time indeed.

And what is more, while the private sector is running a surplus (hoarding money) the government must run a deficit (i.e. must borrow more than it earns, ratcheting up the national debt). What we need is the converse - the private sector running a deficit - borrowing to invest and making profit - and the government to run a surplus (paying down debt with the extra as well as investing in infrastructure).

The govt is the one with the power to take a different path - to move more decisively from spending to investing. It can borrow at much lower rates than the private sector over longer terms and has a huge asset base so the risk is very low. There is risk of course, but the is greater risk from the current strategy of austerity and inaction.

The failure on the part of the public to distinguish between spending and investing has been exploited by the government to pursue their ideologically driven policies. They won't borrow and spend as they say, but in this they include borrowing for investment as though spending and investment were exactly the same. Their investment program is far too small to make any difference. Plans to invest more always involve spending less in other areas. The extra investment is too small, and the impact on demand of less spending is far more significant. With investment lumped in with spending the government is able to maintain minimal support for their policies - though cracks are beginning to show.

Beyond the present government it's not clear whether Labour, the current opposition, are any more able to make the distinction and exploit it than the Tories and their LibDem sidekicks are. labour have said they would cut less, but not whether they would invest more.

National Accounting

In his excellent blog on national accounting, Edward Harrison makes the point that when the private sector is in surplus the government must run a deficit. Very clear evidence of this can be found in today ONS Economic Review for March 2013. By regraphing chart 4 we can see the inverse relationship between public and private finances. At present the private sector are running a large (but diminishing) surplus. And the government is not saving but borrowing. This graph only shows from 2008 onwards, but it is striking how closely these two amounts mirror each other.

Harrison argues (from the Austrian school of economic thought) that the sum of the sectoral financial balances must net to zero. And he points out that a government deficit is an effect of activity in the private sector, not a cause. 

"Budget deficits are the result of the ex-post accounting identity between the sectoral balances and should not be a primary goal of public policy."

The End Is Nigh

Money Week are predicting a financial Armageddon in the near future.

The basic idea is that we've over-committed ourselves to welfare spending. At the same time private debt (my hobby horse) has also sky-rocketed. Money Week put the UK's total debt at something like 900% of GDP though I struggle to see where they get this figure. Private debt is about 440% and static, and government debt is 73% and rising. They seem to derive the other 400% from welfare spending commitments. We can just about get away with it for now because interest rates have been getting lower for 30 years. The problem will hit when interest rates start to go up again and the government will not be able to afford to pay it's debts. This will trigger a downward spiral. And interest rates have reached their nadir according to Money Week. Sometime soon they'll be going up.

Since their track record of predicting disasters appears to be pretty good this seems to be worth taking seriously. They also have history on their side. No nation in history with this level of debt has avoided financial collapse. It's only a matter of time. They're offering some free advice on the problem, and some free issues, so tying the prediction into a circulation drive. This looks a little cynical, but they do appear to be sincere in the warning.

In the Video version you see the text on the screen one sentence at a time and some one reads it out in a detached and emotionless voice. It ain't hardly Max Keisier. Frankly I think they wasted their money creating a video that is mainly the same text and audio - and has no controls, no timer (it's over 30 mins long) and no way to embed it elsewhere. I don't think it adds much to reading it for yourself. And in the video the charts tend to flash by too fast. I'd suggest reading it for yourself and lingering over the charts.

Now the charts are problematic. They present all their charts in £ terms. So government spending is going sky high in real terms, but such a chart doesn't take into account population growth or the growth of the economy (which both grew exponentially till 2008). I think this detracts from the story a little as it's choosing rhetoric over clarity. Spending as a percentage of GDP is a totally different picture. It's still going up, but the situation is less bad than say 1945 - and Money Week choose to make it look much, much worse.

Yes, the British population is ageing, but immigrants tend to be young and have larger families. What is this doing to the population profile?

I asked a couple of the heterodox economists I know on Twitter and they reckon it's scaremongering in search of customers. "They're trying to sell stuff". Probably true - they are a business. But perhaps it's worth having a gander at the argument to see for yourself.

Meeting my MP

In July 2012 I went to see my MP, Dr Julian Huppert (LibDem), about the levels of Private Debt in the UK. I showed him the chart from the 2011 Budget Report which showed that private debt was about 480% of GDP.

Afterwards he wrote to me

Thank you for coming to see me at the Guildhall to discuss the concerns you have about private sector debt. 

As discussed, I have now written to the Chancellor to ask for his comments on the issues you have raised. Please find attached a copy of this letter and I will write to you again as soon as I have received a response. 

I hope that this will be helpful and once again, thanks for bringing your concerns to my attention.

What he wrote to George Osborne was this (extract):

I would be grateful to know your thoughts on how levels of private debt can be brought down in the UK and the effect you anticipate that this may have on our economy. Additionally, I would be interested to know what the UK has been doing to encourage other EU countries to work to reduce the amount of private debt they have and what effect you believe this will have on the stability of the Eurozone.

My constituent does not think that the Government is paying due attention to our levels of private debt and it would be helpful if you had any comments which I could pass on to him.

Eight months later I've not had any response and attempts to nudge Dr Huppert on Twitter and by email have not produced any responses. I sent an email on 5th December reminding Dr Huppert that went unacknowledged. I can only presume that this issue is of no interest to George Osborne and that Dr Huppert has given up expecting a reply from the Chancellor - not even a form letter apparently, not even an acknowledgement. 

I'm putting this online in the hope that it might facilitate an answer. I noted earlier this month that the updated chart shows that private sector deleveraging stalled in 2012. The level of debt has been stuck at 440% of GDP for more than a year. I don't think it's too much to ask how the government about these figures.

Gove's Hostility to Academia

This is an edited version of a comment I made on an opinion piece in the Independent. Monday 25 March 2013. (Seems like the original comment has been removed anyway). Luke Brunning asks, a little naively I think:

How can we have an Education Secretary so hostile to those who work in higher education?

My question is, given the last forty years, how could we not?

It seems like Gove is channelling generalised hostility to academia - as witnessed in some of the depressingly hostile comments on Brunning's piece. To some extent this is a problem of how social sciences are presented to the public. And thus the fault of the social sciences themselves. Academics have lost crucial battles for the attention and admiration of the public. There has been much complacency. Ironic given that the study of the social sciences is 'the public' and they if anyone ought to have understood how to communicate with them. But, no, they allowed others to frame the discussion and to dominate it.

It's not only social sciences that are facing this hostility but arts, literature, history, and everything outside business studies and applied technology. It is hostility towards any threat to the business interests that currently (indirectly) run the world.

In short, NeoLiberals have been framing the debate. Back in 1971, Lewis Powell, in his infamous memo, identified the social sciences and 'liberal' (i.e. socially liberal and politically left-wing) academics as a particular threat to US business interests. Anyone that made people think about their relegation to being a mere consumer of the shit that business pumps out was a threat. Campuses have been aggressively targeted by NeoLiberals - funding for NeoLiberal programs and chairs, but also this cultivation of an hostility towards the threat subjects. The pursuit of profit is at the heart of the NeoLiberal agenda. A lot of quisling academics have gone along with this take over by philistines and done well out of it. Economists being at the forefront of this collaboration.

What Gove is doing to education and what the government are doing to welfare and health, they are doing in fulfilment of a prophecy. The prophet of the NeoLiberals was Lewis Powell and his catechism, the Memo, outlined the NeoLiberal response to the rise of socially liberal values in the USA and elsewhere. Part evangelical tract, part declaration of war, part social engineering blueprint, the Lewis Powell Memo encapsulates NeoLiberal values and urges conservative business people in America to rise up against the threats to their hard won hegemony over the world. But the action spreads out into conservative politics and other social institutions. A decade after the Memo Evangelical Christians were mobilised to support this agenda since it overlapped with theirs. Fundamentalist Christian morality was seen as far more consistent with business values that liberal Christianity or humanism. They have also received help from those militant atheists who attack the very idea of universal values and cultivate a kind of relativism and nihilism amongst the people. The result is a triumph of the values of business - consume, consume, consume.

At present NeoLiberals appear to be winning the battle for hearts and minds. You know they are far ahead when the British Labour party adopts NeoLiberal economic approaches! A few of the comments on Independent article show just how far they have framed the debate and cultivated hostility towards thoughtful subjects.

It is not more than a century since Britain prided itself on the quality of it's philosophers and historians. Hume, Locke, Berkeley, Wittgenstein and Popper (if we can claim them), Bertrand-Russell - were world class thinkers and writers who helped to shape the modern world. Admittedly analytical philosophy did a great deal of damage to that reputation, but we still have some fine intellectuals. However the balance has shifted towards science intellectuals. This is, partly at least, because scientists have staged a very successful campaign to capture the imagination of the public. Through figures such as Prof's Brian Cox, Jim Al Khalili and Alice Roberts science is presented as a fascinating and exciting glimpses into the world. But they do so in ways that do not threaten the hegemony of business interests. They do not question the role of the consumer, or the hegemony of the producer. We might question abstract ideas such as our place in the universe, but there is no questioning of our place in the social order. Economics could not stand the kind of treatment that Jim Al Khalili gave to electricity or chemistry because it is based on an almost religious ideology rather than the empirical method. Such a think show would never make it to air.

So now we hate intellectuals who force us to look at questions about our lives that are intensely uncomfortable. The hegemony don't want us to think about philosophical issues like social and economic inequality. They don't want us to think about the implications of banks operating at pre-crisis profit levels in a lengthy depression. They don't want us to question the ethics of CEO salaries rising exponentially in times of economic hardship when average real wages are falling. They don't want us to think about how this all looks in light of the history of our nation. So we get dramatisations of Dickens, but no history lessons. And Gove will see to it that all subjects which might awaken our critical faculties are dumbed down, and learnt in a fashion that steers away from asking questions.

Now certainly we can point the finger at changes wrought by the aggressive take over by business. But as I said earlier, the academics themselves were well placed to understand the public and communicate the value of their own subjects. But they don't seem to have managed very well. If we had only had a more active interest in the propositions put forward by the NeoLiberal vandals in the 1970s we might have had a different present.

We will look back on this period in much the same way that Germans look back on the 1930s and we will wonder how we could have let this happen. How we could have let our values be degraded. How did our selfishness allow us to let terrible things happen to others in our communities. We will wonder what we thought we would get from endless consumption. We will wonder why the resistance to NeoLiberalism was so ineffective. We will wonder how our heritage was sold off to the highest bidder. Did we learn nothing at all from history or literature? Did we learn nothing from studying psychology or societies that NeoLiberals could just walk all over us? Apparently we did not.

Academia complains, and with some justification, about the degrading of our great universities from places of learning to places of profit seeking. But where were academia when the seeds of this revolution were being sown in the 1970s? Now it's too late, the change is a fait accompli. A new Dark Age is upon us. Gove is an angel of the NeoLiberal desire for profit above all other values. We knew all along what this path would lead to. We English ought to have no delusions about the perils of power because Shakespeare spelled it all out for us 400 year ago. 150 years ago Charles Dickens described a world were middle-classes were content to get on while the poor were exploited. But he also described a world which had abolished slavery and was about in build public libraries. As well.

Best of luck to those people who think a world run by NeoLiberals will be kind to them. Consume, consume, consume.

The Worst Recession Ever?

Here is NIESR's chart showing the path of recession and recovery in various previous downturns, updated for their estimate of monthly GDP, published March 12, 2013.

from Not the Treasury View

So certainly this is the longest recession ever. Indeed all this talk of double- and triple-dip recessions is meaningless. We're been in one long recession since 2008. Growth has been virtually zero for about 30 months or 2.5 years. It is 60 months - 5 years - since the peak of GDP was reached on the back of a massive debt fuelled bubble.

With the government determined to pursue reduction of the fiscal deficit at any cost, the stagnation will no doubt persist for the foreseeable future - based on what I've read I'd say at least another 10 years (2023).

We were going to have to pay for the debt bubble one way or another. The growth rates under New Labour were unrealistic and unsustainable precisely because they relied on everyone, including the government, borrowing money to finance spending. And it was spending rather than investment. Investments pay dividends but we have little to show for our spending spree.

And what will it take to get everyone to see that this is no ordinary recession?

The Most Important Chart You'll See This Year

This is an updated version of a chart I've used before - from the recent Budget Report (chart 1.3). It shows private sector debt in the UK. This chart shows ONS estimates and in previous years these estimates were lower than those produced by McKinsey. However let's take it at face value.

From the 2013 Budget Report.

What this shows is that private debt is still ca. 440% of GDP. Household a little under 100% of GDP and non-finance business debt at about 105% of GDP.

Clearly there have been some deleveraging from the peaks in 2010, in the order of 50% of GDP (About £750 billion). But none of it was in 2012.

Households account for very little of the deleveraging, perhaps 10% of the total (and recall that the OBR predict household debt will rise to 2018). Non-finance business debt has dropped by about 10% points. Most of the deleveraging has in fact come in the finance sector - and most of their debt is owed to each other.

The most important thing this chart shows is why growth is slow.

Growth is slow because demand is low. Demand is low because non-finance business and household debt have doubled in the last 20 years.  

The last 20 years were not years of increasing prosperity they were years of increasing personal and business indebtedness. 

We can't expect more private investment to change this situation. Only government investment can turn this situation around. If the private sector invests while it's customers are mired in debt, then the investment won't pay off because there won't be increased spending to make the investment pay off!