Bent Sofus Tranøy University of Oslo and Hedmark University College

1. 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 SofusTranøy University of Oslo andHedmark University College

2. Outline of the talk • 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

3. What is a supermodel? • A model economy that is fashionable for a while • Becomes example of ”best practice” • Emulation => imperfect institutional isomorphism

4. Rises to prominence Throughgoodness of fit with trends in the world economy. i.e ability to utilize cheap and abundant resources • Untapped labour, “costless” dumping of pollutants, some raw material • Perceived ability to solve problems that seem particularly pertinent at any given moment in time • Inflation, unemployment, export performance, innovation, female participation combined with fertility • Indicates an ideational component: • 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

5. A brief history of supermodels I • US Fordism • Masters of mass production • French indicative planning • Impressivegrowth and infrastructure achievements • Northern European Corporatism • Ability to handle inflation/stagflation • Japanese Coordination • Industrial miracle • Model Deutschland • Combining hard currency with export performance • Flexible specialization • Regional response to the crisis of mass production

6. A brief history of supermodels II • Asian Tigers – export led growth • Late, but impressive growth spurts • Celtic Tiger • Impressive growth performance, successful “hotel state” strategy • Finnish innovation (and education) miracle • Generalizing from Nokia? • Flexicurity – combining dynamic labour markets and social security • Danish growth and employment performance • Dutch Miracle • Nordic Model • Trust, welfare, coordination and productivity

7. Flashpoint: Rhenishvs Anglo-Saxon capitalism • The Albert position: • Defending the longtermism and social embeddedness of the Rhenish model • Return fire: the US-”jobs machine” position • Always explained in micro-terms (flexibility), never macro • VOC adjudicates: • Two institutional equilibriums identified, • Based on complex interplay between five subsystems: • Inter-company relations, • Finance (or a market for corporate governance), • Industrial Relations, • Skills and training, • Intra-company authority relations

8. 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

9. 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

10. 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

11. 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 • Thenext two slides show a afavourite example of mine, OECD on Iceland • (special thanks to Herman Schwartz)

12. OECD take one • 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

13. 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

14. 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

15. 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)

16. 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

17. 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

18. 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 biasand low risk of getting caught • Cultural change? • Market discipline and market based quality control cannot be taken for granted • 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

19. LMEs in lightoffinancializationunhinged 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

20. Financialization and the welfare state • Whatarethe linksifany?

21. 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

22. The financial sector and the state • The financial markets and the welfare state as alternative mechanisms for welfare allocation • 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. • 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

23. 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?

24. Approaches to instability – rational cheats

25. Opportunistic Keynesianism • Intellectual underpinnings “secured” through temporary application of animal spirits type theory of action • “Wall Street got drunk” (GWB) • Note contrast to Asian crisis intellectual fall-out • Crony capitalism • Structural explanation requires structural reform, conjunctural explanation justifies Selective Keynesianism

26. Concluding remarks • 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?