The Psy-Fi Blog

Lifestyle - Are You a Bond or a Stock?

psyfitec@googlemail.com (timarr) — Sat, 31 Jul 2010 07:00:00 +0000

A Default Lifestyle

Over the last few decades governments have been increasingly moving retirement investing decisions away from companies and onto individuals. Unsurprisingly – at least to anyone who spends any time in the real world – this has led to a lot of poor pensioners and rich fund managers. Slowly, the world has begun to recognise that simply entrusting people with responsibility for managing their own savings is quite a dangerous thing to do: people don’t behave as the models predict. Frankly people don’t even behave as they themselves predict.

In response to this we’re beginning to see the creation of a set of default investing options designed to remove some of the behavioural effects from the process. Amongst these is the idea of the lifestyle fund which defaults investors into a set of investment options that changes as they get older. While this is, in theory, a goodish idea, it doesn’t come close to addressing a fundamental problem which is that people’s wealth is constituted of both their savings and their ability to earn in future. If your job is safe as a bond then investing in shares is probably a good thing, but if it’s not then the default option may be utterly non-optimal.

Democratising Poverty

Over the last couple of decades changes to accounting rules have forced companies to estimate their pension liabilities a bit more than they used to. Which isn't saying a lot, to be honest. Anyway, some of the world’s largest corporations, including the majority of its airlines, have suddenly discovered that they’re no longer global behemoths bestriding the world but are, in fact, glorified pension funds with small businesses tacked on the end.

Governments too are becoming uncomfortably aware that their future pension liabilities exceed their potential tax take and having paid today’s pensioners with money raised from today’s taxpayers are trying to figure out how to tell the latter that they’ve been stiffed rotten by the oldies. All of this retirement malarkey has led to politicians and corporations starting to push onto individuals the responsibility for figuring out how to save for their retirement.

It’s taken a while but it’s eventually become clear that this process has led to a relatively small number of fund managers looking forward to a very long and comfortable retirement and a very large number of ordinary employees looking forward to living on a diet of beans and daytime TV. As we know, it’s turned out that most people aren’t very good at investment. Mostly they choose whatever default option is offered to them – which often has meant they haven’t bothered saving at all. When they do choose they have a nasty tendency to invest equal amounts in all the options offered, which leads to bizarrely skewed portfolios, rather like choosing one of everything on a supermarket shelf: 42 varieties of sugar-enhanced cereals and an apple, anyone?

Delgating Responsibility

Worst of all, however, they have no idea of how to manage their investments at the different stages of their lives. What may be a perfect sensible equity only pension choice at thirty is a devastatingly dangerous one at sixty: you can take a stockmarket crash in your stride early in your life but the closer you get to ending your earning days the bigger the risk is. This observation has led to the rise of the lifestyle fund in which the fund manager takes responsibility not just for the portfolio selection but also for changes to it as people grow older: equities early on, bonds later, sort of thing.

As we saw in Save More … Tomorrow the idea of defaulting people into retirement savings funds that are in their own best interest seems to work and a study by Olivia Mitchell and colleagues shows the same effect for lifestyle funds – if an employer designates such funds as the default choice the adoption rate increases by 66%. Additionally they seem to be attractive to people with low levels of financial literacy making voluntary decisions. The researchers also point out that there’s a spillover effect as some investors use lifestyle funds as an element in a mixed portfolio. Overall, though, the impact is the desired one – a more balanced set of investments:

“For pure investors electing lifecycle funds on a voluntary basis, adopting the lifecycle offerings boosts equity exposure with age, eliminates extreme asset allocations, enhances portfolio efficiency, and reduces nonsystematic risk exposure”.

All of which isn’t a bad idea, apart from the fact that it tends to assume that we’re all the same.

Human Capital

But we’re not all the same: each us is different economically speaking because each us brings with us a different store of human capital. Some of us are stocks and some of us are bonds and treating those two imposters both the same is equivalent to lumping an A list Hollywood star and a bit-part commercial actor in the same category and then wondering why the former’s a lousy tipper.

So what’s human capital? Wikipedia defines it as: “the stock of competences, knowledge and personality attributes embodied in the ability to perform labor so as to produce economic value.”

This, of course, is why we rarely quote from Wikipedia.

Risk and Lifestyle

Turning that into English it’s basically whether you have skills that can usefully be transformed into cash. Such skills can be immensely valuable if they’re hard to replicate and if you’re a brain surgeon you may well have a very long and lucrative career ahead of you sawing away on human heads. On the other hand if your main ability consists of pushing trolleys about a car lot then your store of human capital is, to be frank, rather on the low side. You should perhaps consider using your limited skills to retrain as something slightly better – a stockbroker perhaps. “Better” of course does not necessarily equate to “more useful”.

At any given time each us has a capital value that consists of a combination of our physical capital – the value of our possessions including cash, investments, property and so on – and our human capital. Intuitively we can see that if our human capital is high – our future earnings prospects are good – then we can afford to take a few more risks with our physical capital. The reverse is also true, of course – it doesn’t make much sense for our car lot attendant to be gambling on stocks with cash they may never be able to replace.

Bad Lifestyles

Inevitably, therefore, lifecycle funds will lead to younger car lot attendants being misallocated equity funds and older brain surgeons pushed into pointless bonds. As Luis Viceira point outs in Life-Cycle Funds:

“Arguably there is considerable heterogeneity amongst investors with respect to their risk tolerance and the characteristics of their human capital. Therefore, individually managed funds would be more appropriate than a single asset-allocation fund, since they can take into account these individual-specific characteristics when making asset allocations”.

Unfortunately this brings us full-circle to having behaviorally challenged investors managing their own money – badly, usually – or fund managers enriching themselves. Unfortunately there may be an even worse problem because even if the individual decides to use a lifestyle fund they still have to choose which one, and they’re not all the same. Here’s Viceira again:

“The equity allocations of life-cycle funds and life-style funds are typically heavily biased towards US stocks … The empirical evidence available suggests that a well diversified portfolio of equities should include a healthy allocation to international equities”.

Paternalism Lite

Fund managers are just as prone to behavioral mistakes as individuals: they just do them on a grander scale. However, on the positive side, the re-framing of complex portfolio decisions over time into a relatively simple one – buy a lifestyle fund – you would think has to be an improvement for most people. The question is whether it’s possible to get them to adopt them.

The brutal reality appears to be that a dose of paternalism is good for most investors, regardless of their human capital. Naïve investors especially benefit, probably at the expense of the more sophisticated individuals who continue to invest in their own unbalanced portfolios for the same reason they prefer to drive a car over taking public transport – the misguided belief that their life and their savings are safer in their own hands. Maybe even brain surgeons need some decisions taken out their hands, however safe they might be.

Related articles: The End of the Age of Retirement, Do Behavioral Funds Work?, Save More.. Tomorrow

Moats, Unbundled

psyfitec@googlemail.com (timarr) — Wed, 28 Jul 2010 06:49:00 +0000

From Wheelwrights to Press Barons

Imagine yourself as a fourteenth century European knight: safely tucked up in our crenulated castle, defended by our deep filled moat, we’re the confident lord and master of all we can see. Yet we’re on the cusp of a technological revolution that will overturn our beliefs and destroy our way of life. Cannon are coming and our moats are about to become prisons, not protection.

Technological advances beget market dislocations, as old business models are overturned and new ones tentatively created. English surnames tell of such changes – Wrights and Smiths now far outnumber wheelwrights and blacksmiths, vocations long in vogue and now irrelevant. Now a new generation of knights stand watching their battlements blown apart as newspaper barons and music moguls desperately try to shore up their crumbling estates. They’re on a hiding to nothing, of course; the invisible hand is unbundling their once impregnable moats through the medium of the internet.

Moats in Decline

From the mid- fourteenth century onwards the Hundred Years War pitted various noble houses against each other for mastery of France. One of the predictable effects of this conflict was an arms race, ending in the last battle of the war, at Castillon, the first time a battle was decided not by force of arms but by artillery. The development of gunpowder and the creation of cannon changed the face of warfare forever.

Out of this foment arose the science of chemistry and the engineering processes of metallurgy; the re-imagining of gunpowder for weaponry and the development of cannon capable of withstanding the forces generated by exploding projectiles. Overnight the intrinsic value of large defensive castles surrounded by moats collapsed. Often along with the buildings themselves.

When a Moat becomes a Prison

This, of course, is the other side of the investor’s dream business: a company with a natural moat that protects it from competition. Sometimes the moat becomes less a defence and more a prison. Technical innovation has destroyed countless businesses that once seemed impregnable and it’s surprisingly hard for a corporation steeped in a particular way of doing business to modify its behaviour. Dismantling decades of corporate practice and starting afresh is all too often too difficult.

In living memory we’ve seen market leaders like Xerox and IBM usurped as they were undone by unpredicted changes, before re-inventing themselves. They didn’t so much lose their market leading positions as wake up one morning to discover that their markets were no longer worth leading. This has happened far, far more often than we fondly imagine and, as we track back through the decades we find countless examples of apparently superb and untouchable investments failing to survive unexpected environmental changes.

According to Leslie Hannah in 1900 44% of the world’s stockmarket capitalization was accounted for by railroads. An Egyptian company was the world’s largest non-railroad corporation, although mainly for geographic reasons, on account of it being quite hard to move the Suez Canal. This is the vicious Darwinian nature of the markets: today you’re a T. Rex, king of all you survey, tomorrow you’re a bag of bones presenting an embarrassing puzzle for Biblical scholars.

Bundling in Reverse

The rise of the internet, search engines and a range of new intermediaries is a direct threat to those businesses whose business moats rely on the creation of digitally distributable content and, in particular, those that rely on bundling different types of content to create a package with a single price. As any decent procurement person can tell you, the art to knocking down the cost of your suppliers is to slice and dice their content into different pieces so you can price compare with competitors. Only those suppliers of bundled products with enough muscle and moat to prevent this can truly protect their businesses.

Two types of businesses are now in a desperate rearguard action to defend their collapsing defences – music producers and newspapers. Both of these are finding that their pricing models are being pulled apart by the gravitational pull of the internet. Music producers have long profited by bundling individual tracks which people want with those that they don’t really care about; the CD album is the classic piece of bundled media, oft justified on artistic grounds: an album is a complete work in its own right, not a set of separable tracks is the claim.

Such a position may be defensible by those rare bands that don’t release singles but otherwise is simply an attempt to maintain the pricing premium that bundling great and not-so-great content together brings. iTunes offers the market people want, not the one the suppliers want to provide. Anita Elberse points out:

"... that providing consistent levels of quality in a (mixed) bundle is paramount to stimulating full bundle sales. All else equal, having a set of songs that are relatively even in their appeal may lead to a higher overall willingness to pay for the bundle"

The fight against illegal copying is a sideline to trying to figure out a new business model that works: the moats are already breached, the barbarians are through the gate, the battle’s lost.

Advertising for News

Newspaper proprietors face a different problem. As this excerpt from Nicolas Carr’s The Big Switch outlines most newspapers are, if you study them closely enough, simply vehicles for advertising, bundled up with a bunch of stuff that has a variable relationship with actual news. If you can unbundle these different pieces of content, extract the newsworthy stories from the rubbish and throw away the advertising – aka use internet search engines – then the business model collapses. The news that the moats once associated with newspapers are no longer working is hardly current – it’s an established fact and the struggles of old media to come to terms with the new are another fascinating sideshow in this story.

So we see the battle lines being joined by the newspaper moguls against the search engines, as they set up paywalls to try to defend their positions. Unfortunately this is also largely a battle that’s been lost unless they can find new ways of attracting interest. Most news stories only need a single internet outlet to satisfy most readers, the value added by the majority of media spinners is negligible. It’s no surprise that attacks by media groups on the privileged position of the taxpayer funded BBC have increased: paywalls aren’t likely to work while the Beeb continues to publish for free.

Who’s the Journalist, Now?

Worse than this, though, the Fourth Estate’s position as the ultimate check on government abuses is also failing. Many of the bigger news stories are now broken by insiders over the net, through blogs and other outlets. How government deals with this development will be interesting and revealing. In most jurisdictions the status of bloggers as journalists with the protection that that status provides is uncertain. The recent police raid on Jason Chen, the editor of the Gizmodo blog who managed to get hold of an early version of the iPhone 4 suggests that this is true, even in the United States where journalistic privilege has long been a shining example to the rest of the world.

Here in the UK our libel laws are roughly equivalent to those of third-world dictatorships, such that re-publishing of fair comment outside of this country via the internet in a form viewable in the UK has been sufficient to allow corporations to use our libel laws to stifle comment under threat of huge financial sanctions. Yet even here the cracks are showing as the science commentator Simon Singh has recently managed to fight off an attempt by the British Chiropractic Society to legally gag him. As the New Zealand Medical Journal said of a similar attempt: “...let’s hear your evidence not your legal muscle”.

The world is changing, the castle walls are crumbling and the moats are filling up with broken masonry. The best investors can do is get clear of the falling debris, fleeing like rats from a foundering vessel. Of course, this rodent behaviour is always presented as a bad thing, but remember: rats leave a sinking ship for a damn good reason.

Related Articles: Reality 2.0 - Interactive Porn and Crumbling Moats, Is Intrinsic Value Real?, Investing Like Berkshire Hathaway

A Brief History of Behavioural Finance

psyfitec@googlemail.com (timarr) — Tue, 27 Jul 2010 08:15:00 +0000

The Nobel Prize for Psychology

Noble Prize winning committees aren’t renowned for consistency. Giving Barack Obama the Peace Prize for not being George W. Bush is a triumph of hope, but hardly based on rational analysis. We might also wonder if the selection panel got its wires crossed when it awarded the Economics prize to a psychologist.

But it wasn’t just any old shrink who got the bauble. It was Daniel Kahneman, half of the dynamic duo that invented the whole topic of behavioural finance. The other half, Amos Tversky, died in 1996. Between them, Tversky and Kahneman pump primed a change in the way we expect stocks to behave. Outside credit rating agencies, it’s no longer enough to assume we can predict market movements on the basis of number crunching on a grand scale. Now we need to take our own mental confusion into account.

Read full article at Monevator >>

Satisficing Stockpicking

psyfitec@googlemail.com (timarr) — Sat, 24 Jul 2010 06:54:00 +0000

Logical Lab Rats

When we make decisions we nearly always do so in the context of something or other. In fact about the only time we’re asked to make contextless choices is in academic exams and laboratory based psychology experiments. As these are the two most familiar situations faced by the academics generating the theories that underpin most of modern finance we shouldn’t be awfully surprised if their great ideas are somewhat lacking in any understanding of … well, anything, really.

Being trained to think logically and probabilistically is a necessary part of being a modern economist, but it’s hardly a requirement for most people in most professions most of the time. You don’t find many baristas trying to make Bayesian inferences about which particular coffee to pour next. We clearly don’t rationalise most decisions, we make them quickly and effortlessly. We don’t optimise, we satisfice.

Satisficing Simon

Satisficing is a concept introduced by Herbert Simon, who argued that people didn’t attempt to solve problems and make judgements in an optimal manner, but merely in a way that was sufficient and satisfying – hence, satisficing. This approach contrasts with both the ideas of classical economics and of the mainstream of behavioural finance, which set up a norm of rational behaviour to measure people against. In the former case the expectation is that people will act in accordance with these principles, in the latter that they will try and fail and, in so doing, generate predictable irrationality: so called behavioural biases.

Now while it’s undoubtedly true that the behavioural approach has taken us away from a standard of rational behaviour that not even the most anally-retentive classical economist could hope to match it also seems that the underlying focus on there being some kind of goal of rationality that we’re to be measured against has generated its own biases. Some of the results of this research program simply don’t make sense when translated to the real world, and increasingly it looks like these deviations occur because there are errors at the heart of behavioural finance.

Simon’s idea wasn’t just that we weren’t achieving some great goal of rationality but that we weren’t even bothering to try, thus rendering a large part of the research program of behavioural finance irrelevant. After all, if you’re consistently scoring people against the rules of snap when they’re playing bridge, you’re going to get some odd results. In some cases these results may be consistently strange, but they’re no less irrelevant than that.

Choosing Toasters and Stocks

Satisficing suggests that rather than trying to meet some optimal goal we’re mostly quite satisfied if we achieve one that’s just good enough. If we want to buy a new toaster we generally have a few basis rules about what we’re looking for: mainly that it crisps bread effectively, is reasonably cheap and occupies less than 4% of our available kitchen workspace. Most of us don’t go around ferociously weighing up all of the myriad features of toasters in order to make a choice.

Generally something similar happens when we go stockpicking. We’re looking, roughly, for the right sort of stock that fits our criteria. We may even plug these criteria into some kind of stock filter and do some basic analysis of what we find. Mostly, though, we don’t hunt around forever because we’re time and processing power limited. Mostly we simply make do with something that looks good enough.

Good Enough

Good enough satisficing is at the heart of Gerd Gigerenzer’s implementation of Simon’s ideas. Because, if Simon was right, then relatively simple satisficing algorithms should generate the kinds of decision making we see humans make. There’s reason to doubt that this will work – after all, we make some pretty complex decisions in real-life so the idea that some, almost trivial, set of checking criteria will lead to some even halfway logical decisions seems unlikely to work, compared to the sophisticated statistical analysis most of economics would expect this process to require.

Of course, Gigerenzer found something pretty much the opposite of what commonsense would indicate: he found that commonsense is actually pretty good at making halfway intelligent decisions. His classic experiment with Daniel Goldstein involved asking participants to figure out questions like: which city has the larger population, Hamburg or Cologne?

Take the Best

The researchers postulated a way of making inferences from memory, a so-called probabilistic mental model. This model worked by assuming that people only have limited information about the task in hand – in this case, German cities – and would use this limited information to make best guesses about which had larger populations. The main algorithm they used is called “Take the Best” which basically works by scanning memory for anything relevant to the task in question – i.e. do we know anything about Hamburg or Cologne – and then deciding whether the information that first comes to mind had any relevance to the question? If it does it’s used to discriminate and make a decision, if not we pass on and look for the next cue.

In the case of the German cities the experimenters came up with a plausible list of possible bits of information that someone might hold – whether it’s a university town, has a major soccer team, is the capital, etc. Running their algorithm against various partial bits of knowledge they successfully managed to generate high rates of successful decision making, comparable to those that used more traditional decision making processes.

Predicting Irrationality, Darwin-Style

This approach also makes an interesting and completely counterintuitive prediction. Under classical theories the more knowledge you have then the better your success rate should be. Take the Best, however, predicts that as you gain more knowledge your success rate will decline. The reason is that the cues used to make the predictions are not 100% certain to correctly correlate with the target concept – not all larger cities have soccer teams, for example. Hence, the more information you have the more likely the algorithm is to betray you. When the researchers tried this out in real-life this is exactly what they found – students in the Germany were better at judging which American cities had the larger population than with cities in their own country, the so-called less-is-more effect.

Moreover, using the same approach the researchers were able to explain the strange appearance, disappearance and inversion of the overconfidence bias that’s seen in various experimental situations depending on whether we’re asked about whether we’re correct single events decisions or about the frequency of multiple ones. This is because behind the approach is the idea that we have a toolkit of these satisficing heuristics that we apply in the appropriate circumstances and these different situations invoke different ones.

The key is that these heuristics are adaptive: they’re constructed for different tasks and they utilise information in the environment – so-called “ecological rationality” – in order to ensure accuracy. So, at root, satisficing is a Darwinian theory, assuming that complexity in decision making arises out of adaptive principles. As Todd and Gigerenzer suggest:

“The adaptive toolbox is inspired by a Darwinian vision of decision making in humans, animals, and artificial agents. First, just as evolution does not follow a grand plan but results in a patchwork of solutions for specific problems, so the toolbox is structured as a collection of mechanisms that each do a particular job. Second, just as evolution produces adaptations that are bound to their particular context, the heuristics in the adaptive toolbox are not good or bad, rational or irrational, per se, but only relative to a particular environment. From these two features springs the potential power of simple heuristics: They can perform astonishingly well when used in a suitable environment.”

Kick the Bricks

There’s "ecological rationality" in the idea that most human decision making is through satisficing heuristics rather than internalised statistical reasoning. If this idea is correct it kicks a few bricks out of the foundations of most of the existing approaches to understanding human behaviour in financial systems. It also holds out some hope that the mish-mash of confusing and contradictory evidence from existing research may actually be underpinned by some common theme.

We shouldn’t hold out too much hope, though. If these ideas are correct we’re dealing with an adaptive theory so as soon as we get a handle on it it’ll mutate, while, as we’ve seen, such theories are fiendishly difficult to disprove, a key criteria for scientific plausibility. Still, t’would be boring to know everything, don’t ya think?

Related Articles: Metaphors of Mind and Money, Behavioral Finance's Smoking Gun, Unpredictably Rational

Weightless Economies

psyfitec@googlemail.com (timarr) — Wed, 21 Jul 2010 04:55:00 +0000

Dangerous Economists

Although economists are generally a fairly harmless group there’s the ever present danger that they’ll get someone or other with some real power to actually listen to their beliefs. Once that happens we’re all potentially in trouble as the subtlety of the real-world gets lost in an economic miasma. A case in point was Selective Employment Tax (SET).

Introduced into the UK in the 1960’s it was a levy so self-evidently stupid even most of Britain’s notoriously supine representatives recognised its imbecility. Yet, backed with the imprimatur of one of the foremost economists of the day, the government went ahead and implemented it anyway in the quaint, old-fashioned belief that money earned through manufacturing is somehow “good” and that through services “bad” – just in time to miss the growth of the knowledge economy. Thus proving that the only thing worse than a politician with an idea is an economist with a Big Idea.

Balance of Payments Blindness

The idea behind SET was twofold – to fix Britain’s balance of payments deficit and to encourage manufacturing industry. Oddly, though, neither of these conditions is obviously an issue in need of resolution: essentially SET was a solution to a problem that didn’t really exist anywhere other than in people’s minds.

A balance of payments deficit isn’t necessarily a problem as long as you can pay the interest on the debt. Government debt isn’t like personal debt – countries, in theory, last forever and so, in theory, can their debt. The idea that countries should export more than they import was given the lie by Adam Smith in The Wealth of Nations:

“Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false.”

Mercantilists and Protectionists

Smith was railing against the view of trade known as mercantilism, which believes that there are winners and losers from free trade and requires protectionist measures to protect a country’s interests. Of course free trade begets winners and losers at the corporate level, but not at the national one: therefore, it’s usually the corporate losers who demand trade barriers.

Yet two hundred years after Smith we find the British government was still in thrall to it. Not just did it seek a positive balance of payments as an “obviously” right thing but it also sought to boost manufacturing industry over services. These two issues are partially linked – manufacturers build goods which can be exported for hard currency, much more obviously than the export of services which tend to be invisible.

S.E.T.

The solution proposed in sixties Britain was Selective Employment Tax: a tax on the employees of services companies with an offsetting bonus for those employed in manufacturing. In all honesty it’s hard to know where to start the criticism, so perhaps a few facts are in order. The government taxed all employees at source, so everyone had this deducted from their salaries. Manufacturing companies had to apply to the government for their refunds and bonuses, which meant a whole new bureaucracy had to be created to administer the tax and to make subjective decisions about which industries were involved in “manufacturing” and which in “services”.

The madness continued. A further group of employers were classified as neither manufacturing or services – agricultural groups, transportation companies and so on. These had to pay the tax anyway but then had to reclaim it. Most service companies promptly put their prices up, or laid off employees. And all of this was in order to encourage workers to move from service industries to manufacturing when the service industry had been employing people at a rate seven times in excess of manufacturing over the decade.

Kaldor's Virtue

The architect of SET was Nicholas Kaldor, a Hungarian economist who became advisor to a sequence of British financial ministers. Kaldor believed that:

“Those nations that developed their manufacturing sector embark on a virtuous cycle of productivity and income growth; in contrast, those nations specializing in agriculture or services will experience stagnating productivity and incomes, and a vicious cycle of decline.”

Kaldor's beliefs were based on empirical data, but with limited historical scope, and his academic theories about how economies really work. Unfortunately the love of hard manufacturing over soft services seems to be as much an emotional and psychological issue as one governed by hard, rational economics. There’s something about making real, physical things that somehow seems more valuable than the provision of what economists call “weightlessness”: services, not goods.

Weightlessness and Dematerialisation

Along with weightlessness comes the concept of dematerialisation: information is power, or at least money. Dematerialised objects are, in the jargon, infinitely expandable – if you read this article and find it useful (or not) then that makes no difference to whether it can be used by the next person or not. A bottle of wine, on the other hand, can be consumed once and only once, however pleasant the experience.

Dematerialisation brings its own problems – ideas are relatively easy and costless to generate but may be harder to protect, for instance. However, the weightless knowledge economy is the present and future of business as studies of the relative importance of services conclude:

“…that for growth, the services sector is the most important in all advanced economies. In economies with per capita GDP of at least US $5,000, the services sector accounted for more than 40% of that economy’s growth performance. In 80% of economies having per capita GDP of at least US $10,000, the manufacturing sector contributes less than 20% of that economy’s growth performance."

This, of course, is a world away from Kaldor’s dream of a British manufacturing resurgence yet you’ll still find leaders of countries pining for a way of re-establishing lost manufacturing glories. Probably this is because it’s harder to move manufacturing jobs – and votes – than services, but in the end it’s now ideas and knowledge that rule our world, not welding and riveting.

Away from the Ivory Towers

Kaldor was unquestionably an economist of genius but some ideas, no matter how good, simply can’t be made to work in the real-world. As Carole Nakhle records of him in Petroleum Taxation:

“… when other governments called on his advice and tried to introduce his ideas the results were catastrophic, leading in several cases to governmental overthrow, revolution and violence. For example there were riots in India when his tax advice was applied. In Sri Lanka there were also violent protests. In Mexico the government fell, also in British Guiana. In Ghana there was a coup, in Turkey, riots, in Venezuela a change of government – quite a record.”

Like so many of his ilk Kaldor seems to have been unable to translate theory into practical actions when faced with the nasty complexities of the real world. He also seems to have been fooled by his own knowledge of past glories, as he translated these into the basis for future success through a set of ideas that were outdated before they were even introduced.

Trust in Markets, Not Economists

SET was successful on its own terms: it helped push the British balance of payments into surplus and was a useful mechanism for government mercantilist policies. Sadly neither of these was really in the UK’s national interest because even as SET was pushing employees into manufacturing the rest of the world was dematerialising and setting the scene for an eventual British economic collapse.

The only certain judge of what people want are the free markets. Just because someone proclaims they’re a prominent economist gives them no more insight into the future than the rest of us. As so often, true insight comes from clear thinkers, not straitjacketed economists:

“He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me.”

Take a bow, Thomas Jefferson.

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