Wednesday, September 19, 2018

The misleading narratives of our time

Narratives define our lives. Even when they are completely divorced off reality or any evidence, they exercise vice like grip on our imagination. In fact, all of us, howsoever smart, are captives of narratives.  

Consider some of the enduring narratives of our times. 

People on welfare prefer to stay on and not search for work, thereby necessitating tight restrictions on welfare amounts and duration. Market dynamics ensures efficient allocation of returns on economic activity between labour and capital. Higher minimum wages lead to businesses hiring less or relocating or even closing down. 

Higher taxes discourage people from working and businesses from investing. Higher taxes force businesses to relocate. Capital gains taxes should be lower than income taxes so as to avoid double taxation. Soaring wage compensation is just desserts for superstar executives, attracting whom is essential to compete in the market. 

Large companies are also the biggest job creators. The vibrancy of economic activity is dependent on the economy's large companies. Industrial policy is about providing input subsidies and fiscal concessions - this is what attracts businesses. Foreign direct investment leads to technology transfers, is associated with manufacturing activity, results in large job creation, and is therefore critical to economic growth of developing countries.   

The main role of financial markets is to intermediate capital for economic activities. Financial markets facilitate efficient allocation of resources between savers and borrowers. Capital markets are the most efficient part of the financial markets. Boring banking is inefficient and lazy, even perhaps an example of rent-seeking. Stock markets can be made more efficient by financial engineering and high frequency trading. Stock prices are a fair reflection of life-cycle valuation of the business. Sophisticated financial engineering is productivity enhancing and creates value. Hedge funds and private equity firms contribute to more efficient financial intermediation. What is good for Wall Street is good for Main Street!

Public private partnerships (PPPs) are the most efficient and cost-effective approach to managing infrastructure projects. Private sector delivers more value for money with managing infrastructure projects than the public sector comparators. Infrastructure funds and private equity investments bring in high quality management practices to improve the efficiency of large and long-term infrastructure projects.   

Business competitiveness is about containing costs, especially worker wages, almost to the exclusion of all else, including retaining workers or externalising internal costs. Higher business profitability and surpluses are good for the economy since companies will re-invest them to create more growth and jobs. Higher interest rates discourage businesses from investing. Government regulation of any kind is bad, unless there is a clear market failure and the costs-benefits balance from that regulation is favourable. Mergers and acquisitions help businesses leverage economies of scale and scope to increase competitiveness and maximise profits. Maximising shareholder value should be the objective of businesses.

Digital economy companies are unlocking more value than the externalities they create. The business structure in industries with network effects have to be oligopolistic - therefore the inevitability of behemoth superstar monopolies like Facebook, Google, Amazon etc. The superstar technology companies are the touchstone for innovation. They are led and populated by nerds who have created fantastic products and services on their own.

It is markets, and not governments, who lead on innovation and cutting edge technologies. Most of the great new technologies have   been the outcome of private entrepreneurship and initiative. Most the global research and development (R&D) work takes place in private companies and R&D spending comes from the private sector. The leading companies in their areas, especially in technology and pharmaceutical sectors, invest heavily in R&D so as to stay ahead of the market. The prevailing intellectual property (IP) rights protections are necessary to promote investments in R&D. Innovative technologies from the private sector are the result of IP protections.

Finally governments are invariably inefficient, corrupt, and unproductive. Government officials are slothful, inept, apathetic, and unimaginative. Governments, in general, are sand on the wheels of market enterprise. Governments should be involved only in areas where markets cannot work or till markets become mature enough. Governments need to step aside to let markets unlock value and realise the full potential. 

Where is the evidence for the unqualified embrace of any of these narratives?

Some of these narratives do not stand even a cursory test of empirical scrutiny. Most of them stand on weak ground when faced with empirical evidence. In some cases, the evidence is too confusing to form any definitive opinion. In some other cases, like with executive compensation, the response function may well be a reverse U-shaped curve - higher compensation upto a certain level is good, but it starts becoming counter-productive beyond a certain level. We know about the famous Laffer curve in taxation, though we have no evidence about its actual shape for different contexts - when the rising curve turns around.  

Never mind all these bitter realities, these narratives form the basis for modern capitalist economies. Ideologies are formulated, opinions are formed, policies are made, and behaviours are shaped based on these narratives. These narratives exercise a form of hegemony over the society's collective consciousness.

Accomplished economists speak with great certitude about each of these without anything remotely close to the standard of evidence required to do so, one which they themselves aggressively promote and accuse governments and others of not adhering to. Ideologues and opinion makers confidently follow suit. Newspapers quote all of them and peddle them as definitive. Policies get made. Narratives get entrenched. These become conventional wisdom.

This blog itself has posts, scattered across, on most of these narratives, outlining the evidence to the contrary. The incisive Ha-Joon Chang has outlined several of these with illustrations here

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