Most of us like to think of ourselves as rugged individualists – people who don’t run with the herd. The reality is less romantic: As countless bubbles have shown – from Dutch tulip mania in the 17th century to inflated property prices in the past decade – the prospect of a quick buck means there’s usually no shortage of people happy to get swept along.
The financial crisis illustrated the risks of such herd behaviour. But it also cast a light on another sort of dangerous collective thinking – groupthink. Unlike herd behaviour – where people, businesses or institutions follow each other blindly – groupthink happens within institutions. In effect, because of real or imagined pressure, employees swallow their doubts and allow their thinking to fall into line with the dominant view. In recent months, several reports have exposed how groupthink allowed regulators and officials to ignore alarm bells in the run up to the crisis.
And it didn’t just happen at national level – even the IMF has admitted that its internal culture tended to silence dissent. In a commendably frank report, the IMF’s evaluation office says one reason why the organisation failed to identify the mounting risks to the global economy was “a high degree of groupthink” and “an institutional culture that discourages contrarian views”.
“The prevailing view among IMF staff – a cohesive group of macroeconomists – was that market discipline and self-regulation would be sufficient to stave off serious problems in financial institutions,” the report says. “They also believed that crises were unlikely to happen in advanced economies, where ‘sophisticated’ financial markets could thrive safely with minimal regulation of a large and growing portion of the financial system.”
Although the term itself isn’t used, groupthink also raises its head in the report from the Financial Crisis Inquiry Commission, which investigated the crisis in the United States. It says that too often, regulators “lacked the political will – in a political and ideological environment that constrained it – as well as the fortitude to critically challenge the institutions and the entire system they were entrusted to oversee.”
The report also shows how the pressure to confirm wasn’t just imagined. At the ratings agency Moody’s, company president Brian Clarkson ruled with an iron fist: “According to some former Moody’s employees, Clarkson’s management style left little room for discussion or dissent. [Gary Witt, a former Moody’s employee] referred to Clarkson as the ‘dictator’ of Moody’s and said that if he asked an employee to do something, ‘either you comply with his request or you start looking for another job.’” The report, by the way, is a terrific read.
And groupthink is one of the factors – along with herd behaviour – fingered in a report on Ireland’s crisis by the Finnish banking expert, Peter Nyberg. In banks and financial institutions, it says, “diverging views or initiatives were often not appreciated and only occasionally sanctioned.” Among the regulators, it says of the Central Bank, for example, that there “are signs that, reinforced by the relatively hierarchical structure of the [Bank], a climate of self-censorship had become prevalent”.
Of course, groupthink alone didn’t cause the crisis. Still, it would be foolish not to think about it can be addressed. The reports offer some thoughts on how that can be done: Among a series of recommendations, the IMF report says staff should be encouraged “to be more candid about the ‘known unknowns,’ to be more ready to challenge their own preconceptions” and that managers “should encourage staff to ask probing questions …”. The Nyberg report says “it must become respectable and welcome to express professionally argued contrarian views…”.
Right now, when regulators and banks are still feeling spooked in the wake of the crisis, there’s probably an appetite for contrarian views. But that may not last forever. The real test of whether dissent is really welcome will come in the next boom, or, more likely, the next bubble.
This post comes to us from Fiona Stewart of the Financial Markets, Insurance and Pensions Division of the OECD’s Directorate for Financial and Enterprise Affairs.
Those of us struggling with our commutes to work in France don’t need to be reminded that pensions are on the top of the agenda again in many OECD countries. Workers are understandably perturbed when they feel as if their hard earned right to a well deserved retirement is under threat.
Yet, given the ageing of the population across the OECD region, the scale of the challenge of paying for our pensions is rarely understood. Without reforms, spending on pensions will require an extra 5% of GDP by 2050 – posing a much greater challenge to our economies on a long-term basis than the financial and economic crisis of recent years.
We are all living longer – which is a good thing – and we are increasingly healthy at older ages. When pension systems were first introduced, the retirement age was 65 and life expectancy was 65. Now we might work for 30 years and be retired for 30 years. Lord Turner, who conducted a major review of the pension system in the UK a few years, ago spelt out the choices we have starkly – we can save more, live on less in retirement or work longer.
Some say that corporations making big profits should be taxed more (the banks which were so involved in the financial crisis being singled out) or that governments should cover the rising cost of our pensions rather than individual workers. But this does not solve the problem that the costs of our pensions are ever rising and there are fewer and fewer young workers to pay for them.
One particularly striking (being the operative word) fact in France is that young students are demonstrating against the rise in the retirement age. No one seems to be trying to explain to them that if these reforms do not happen they are the ones who will be hit hardest and have to pay in the long run – as they will have to pay for the decades of retirement their parents are likely to enjoy, whilst, when it comes to their turn to retire, there may not be enough money to pay for their pensions. To the great French cry of ‘Liberty, egality, fraternity’ should be added ‘intergenerational solidarity’!
The complexity of the pension debate again means that the students are mixing the issue with other matters – notably arguing that if the older generation work 2 years longer, they will have to wait 2 years more until these jobs are ‘freed up’ and they can start work. Yet the experiment of the 1980s and 1990s recessions, when early retirement was used as a policy tool to try to fix unemployment, showed that these policies did not free up jobs, but in fact had the opposite effect, as the number of jobs within an economy is not a fixed pie to be shared out.
Fortunately OECD governments have learnt this lesson and are indeed pushing ahead with raising the retirement age – as we saw in the UK this week. Some have also linked the retirement age to longevity increases, making the rise gradual and automatic which should avoid damaging political battles such as these in future.
Sure our pension systems aren’t perfect – and neither are the French reforms. For example, there are still unanswered issues such as how to ensure women, who tend to have broken career paths for child rearing, receive more equal pensions, or how we should treat those in particularly strenuous or dangerous jobs, or the unfairness caused by differences in longevity across social classes. The 40 year contribution period to be introduced into France is fairly long by OECD standards, and arguably hits blue-collar workers more disproportionally But these issues should not cloud the core fact that working a few extra years in retirement is an essential step to putting our pension systems on a sustainable path and securing them for future generations.
As France demonstrates, much still needs to be done by governments to communicate why pension reforms are needed and how we must not only share the costs of our rising longevity, but hopefully celebrate the fact as well.
Under medieval insolvency laws, inquiries into bank failure could use torture and hostage taking to get answers. With the loss of traditional values, today’s investigators can only ask questions and seize documents.
Still, they do produce some startling revelations. Speaking to the US Financial Crisis Inquiry Commission yesterday, Dick Fuld, head of Lehman Brothers when it collapsed, said: “Deregulation of the financial industry and lack of government control helped us to make substantial profits in the years leading up to the crisis, so naturally we only have ourselves to blame for the mistakes and mismanagement that led to our bankruptcy”.
Ha ha, only kidding. In fact, he blamed poor decision-making by, wait for it: the Fed. Here’s what he actually said according to the New York Times: “Lehman was forced into bankruptcy not because it neglected to act responsibly or seek solutions to the crisis, but because of a decision, based on flawed information, not to provide Lehman with the support given to each of its competitors and other nonfinancial firms in the ensuing days”.
So, nothing to do with overleveraging, bad bets or Repo 105, an accounting trick that classifies a loan as a sale, thereby reducing Lehman’s liabilities by $50 bn (but only on the balance sheet).
Governments, as we all know, had to step in to clean up the mess, and not just in the US. From October 2008 to May 2010, more than 1400 bonds backed by government guarantees were issued by around 200 banks from 17 countries, for an amount equivalent to more than a trillion dollars.
Aviram Levy of the Banca d’Italia and Sebastian Schich of the OECD’s Financial Affairs Division look at the consequences in an article for the OECD Journal. They show that the guarantees have been effective in resuming overall long-term funding for banks and reducing their default risk, but at least two major issues now have to be addressed.
First, relatively weak banks with strong governments backing them (“sovereign guarantors”) have been able to borrow more cheaply than strong banks with weak sovereign guarantors.
Second, extending the scheme into 2010 allows non-viable banks to take advantage of the continued availability of guarantees and postpone addressing their own weaknesses or, even worse, adopt excessive risks in a “gamble-for-redemption”.
You can’t legislate against the toxic combination of ignorance and arrogance that brought the financial system crashing down. But governments and taxpayers shouldn’t be seen as blood donors permanently on call to stop banks dying from self-inflicted wounds.
Pity the poor economics undergraduate. Seduced by descriptions of a discipline that “examines how a society provides for its needs”, he or she hands over their student loan and enters the tent with the others. When they wake up the next day, it’s all utility functions, general equilibrium models, externalities, stochastic variations, and trying remember what the difference between monetary and fiscal policy is.
When the jargon does pass into everyday speech, it’s usually a bad sign. Three years ago, few of us had ever heard of “subprimes” for instance. Sometimes though, a term may be technical but its meaning is clear, as in Paul Krugman’s response to our post about the OECD Economic Outlook. Krugman takes issue with Pier-Carlo’s Padoan’s definition of “contractionary”, and the fundamental disagreement is about aspects anybody reading the New York Times will understand, such as inflation and unemployment.
Too often however, debates about economics are conducted in a language that clouds the issues even for experts. So when they want to make themselves understood, they abandon the concepts and vocabulary of the profession and resort to analogy and metaphor.
The debate on the latest Outlook is no exception. Writing in the Financial Times, Martin Wolf launched a stinging attack (as the papers say to distinguish them from soothing attacks) on the Outlook’s recommendations, notably on the need for fiscal consolidation. To get his point across, he writes “Let us translate this proposal into ordinary language: ‘If you are unwilling to starve yourself when desperately ill, nobody will believe you would adopt a sensible diet when well.’ But might it not make sense to get better first?”
Nouriel Roubini uses an even more striking image to describe the mixture of bad loans and other dodgy ingredients that went into creating derivatives: “If you put rat meat and trichinosis-laced pig parts into your sausage, then combine it with lots of other kinds of sausage (each filled with equally nasty stuff), you haven’t solved the problem; you still have some pretty sickening sausage.” And once the financial system starts digesting that…
There’s nothing new about this. In an article about the need for clarity in discussing economic policy, Robert Skidelsky quotes Jonathan Swift, writing in the 18th century: “Through the contrivance and cunning of stock jobbers there hath been brought in such a complication of knavery and cozenage, such a mystery of iniquity, and such an unintelligible jargon of terms to involve it in, as were never known in any other age or country.”
Unfortunately, clarity doesn’t necessarily mean accuracy. Take a look at RBS’s accounts of itself in 2007 when the bank was going to hell in a hand basket. Below a bunch of photos of young people grinning inanely at percentage signs, we read that: “RBS is a responsible company. We carry out rigorous research so that we can be confident we know the issues that are most important to our stakeholders.” Presumably making money wasn’t one of them. To be fair to RBS, they do “recognise that some people’s financial needs may be better fulfilled by organisations outside the banking sector”. The British taxpayers who bailed them out for instance.
Taxpayers everywhere have a right to be informed in intelligible language about the trillions of dollars they’ve been asked for over the past couple of years, and to be told what happened to all the promises of profound change. For the time being though, words written by Rudyard Kipling almost a hundred years ago seem to sum up the situation: “Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew”. Was that the end of the bad old ways? Kipling goes on to bemoan the fact that “the burnt Fool’s bandaged finger goes wabbling back to the Fire”.
Future of capitalism debate with Robert Skidelsky at OECD Forum (Thursday 27 May 2010)
A big crisis, but was it big enough? That’s the question on the mind of Larry Elliott, economics editor of The Guardian newspaper following last week’s OECD Forum in Paris. Elliott went along to one of the event’s most talked-about sessions, “The Future of Capitalism”, which featured contributions from – among others – economic historian Robert Skidelsky and commentator Anatole Kaletsky (who previewed some of the issues raised in the session in the OECD Observer).
Writing later in The Guardian, Elliott reflects on a warning from another session speaker, the OECD’s Adrian Blundell-Wignall, that the crisis may not have been severe enough to prompt much-needed reforms.
“Speaking in a personal capacity … Blundell-Wignall warned there was likely to be a second, even bigger, meltdown unless there was radical reform of the financial sector, including splitting up banks with both retail and speculative arms,” Elliott writes.
“Although this is a sombre conclusion, it may prove accurate. The current crisis has yet to have the cathartic impact of the slump of the 1930s, when the economic cost was far higher and the links between the failure of the old laissez-faire model and the drift to political extremism were plain.”
Geoff Gallop of The Sydney Morning Herald offers another view of the session here.
Over on the OECD’s YouTube channel you can see video interviews from the Forum, including one with Lord Skidelsky, who weighs in on the debate over fiscal consolidation. Or you can just scroll down the page to catch up on the OECD Insights Blog postings from the Forum.
In the wake of the Great Recesssion, does capitalism have a future? Speakers at this morning’s opening session on Day 2 of the OECD Forum seem to think it does, however it might be “capitalism, but not as we know it”.
Both Anatole Kaletsky, an economics commentator at The Times newspaper, and Lord Robert Skidelsky, the British economic historian, have been arguing that we may now be entering a new phase of economic history – what Mr. Kaletsky calls Capitalism 4.0.
They argue that, in broad terms, Capitalism 1.0 began with Adam Smith and the rise of laisser-faire economics, when governments gave way to the power of markets. That began to reverse in the late 19th or early 20th centuries – depending on your point of view – with the rise of social democracy and greater power for governments.
In turn, that yielded to the era of what some have called free-market fundamentalism, characterised by the reforms led by the likes of Ronald Reagan and Margaret Thatcher. Now, once again, the market’s power is in doubt, but what comes next?
Mr. Kaletsky believes we’re entering a new period of pragmatism, when ideology will give way to a more “common sense” approach. He also says cash-strapped governments now face the challenge of having to do more but with fewer resources, which he believes will fuel some creative approaches.
Lord Skidelsky believes the new era may see less of an emphasis on wealth creation for the sake of it: He’s told the session that’s planning a new book on just this issue entitled, How Much Is Enough: The Economics Of A Good Life. “Wealth is a means to an end, not an end in itself,” according to Lord Skidelsky. “Beyond that, the quest for more and more becomes irrational.”
Indeed, the theme of the limits of current models of capitalism to satisfy human needs has cropped up repeatedly. Sharan Burrow, President of the International Trade Union Confederation, has argued that there needs to be a rebalancing, with more of the economic rewards going to regular workers. Avivah Wittenberg-Cox, CEO of 20-first, says we need a shift in values, with a bigger role for women in the economy and overall governance. “If Lehman Brothers had been Lehman Sisters would we be in this mess?” she has asked.
Governance is also on the mind of Adrian Blundell-Wignall, Deputy Director of the Financial and Enterprise Affairs section of the OECD. He’s worried that, even after the crisis we’ve been through, we’re still not doing enough to create banks with high internal walls between regular banking and more risky activities.
How big a crisis will it take, he wonders, before we get the changes in governance that we need? One other big theme worth noting is the view that capitalism may now be morphing into a number of regional varieties – American, Chinese and European were the most frequently cited. Anatole Kaletsky has warned that it’s essential that American capitalism keeps up with the other forms and doesn’t slip behind. In particular, he’s concerned about the implications for democracy if the mode of capitalism as practiced in more authoritarian states becomes dominant. Overall, a fascinating session.
Jobs – or the lack of them – are on attendees’ minds at an OECD Forum session entitled, “How to avoid a jobless recovery”. As moderator Chris Giles, economics editor of the Financial Times, points out, the economic recovery following the recession has yet to be matched by a fall in unemployment (which the OECD projects will peak at about 8½% this year). Concern over unemployment comes against a backdrop of increasing pressure to cut state spending, which many fear could impede efforts to cut joblessness.
And it isn’t simply joblessness that’s a concern, but also long-term and structural unemployment, says Richard Trumka, President of the American Federation of Labor-Congress of Industrial Organizations (AFL-CIO). He believes workers in the United States are “angry, anxious and going through tremendous amounts of pain”, and warns that headline economic figures don’t really reflect the experience of workers. “All the GDP in the world doesn’t mean there’s a recovery. Until people are back in work, they won’t believe in a recovery.”
The jobs crisis is being felt particularly by young people, according to Luca Scarpiello, a board member of the European Youth Forum. He’s been responding to a question about fears of the crisis creating a “lost generation” of young people who suffer permanently reduced job prospects. For young people, he says, that would mean experiencing unemployment as a structural part of their lives, and relying on short-term labour contracts that offer little in the way of training or skills development. The risk of a lost generation also represents a tremendous potential waste of human capital – after all, he says, “we are the most trained generation in history”.
So, what to do? Panellists are discussing ways in which government policies could tackle unemployment – and the risk that cuts in government spending could actually make things worse. The big run-up in government spending during the crisis has raised deficits and public debts, and there’s intense pressure for governments to get their financial houses back in order. That probably means spending cuts.
But as Pier Carlo Padoan, the OECD’s Chief Economist, has pointed out, we must make the right cuts: In some cases, it might even be a good idea to raise spending – especially in growth-friendly areas like R&D and education. But, considering the still-fragile state of OECD economies, is it too soon to be talking about fiscal consolidation? The noted British economist, Robert Skidelsky, has sounded a warning note. “Many economies are on a life-support system,” he says. “Economic output would be reduced if support was turned off.” And, responding to a question from the floor, he’s also queried the benefits of cutting public jobs: “I am always amused by those who prefer the total waste of unemployment to the partial waste of a large public bureaucracy.”
Nevertheless, as announcements from several governments in Europe this week have underlined, consolidation now seems to be the order of the day. But, as Chris Giles has reminded governments in his summing up, that needs to be balanced with a determined effort to cut unemployment.