The View

An ‘A-ha’ moment needed by financial centres and economists

PUBLISHED : Monday, 29 June, 2015, 11:33am
UPDATED : Monday, 29 June, 2015, 11:33am

It’s an odd, rather embarrassing way to sell a car. General Motors, the big-three carmaker that received the largest of the US government’s 2009 auto bailouts, is running an ad campaign based on the theme that its cars are unrecognizable.

As in – they are no longer tacky hunks of junk.

Take the Buick commercials that keeps playing on the TV. A silvery sedan glides onto a residential street as the neighbours, who had apparently heard the news of an impending Buick purchase, look out the kitchen window with mouths agape.

“That can’t be a Buick!,” says the wife. “It’s nice.” A quick visual collage shows people in other scenes and places make similar exclamations.

Buick is made by GM. So is Chevrolet, which is taking the same tact to sell its newest models. “It’s a Chevy?!” an actor exclaims with wonder as she test drives a car.

I am not a conspiracy theorist. In fact, I am an extremely boring centrist type. Which is another way of saying – the whole world isn’t mad. At least in the developed world, things generally work. Our electricity supply is stable, we can confidently put our kids on Ferris wheels, our cars drive, our airplanes aren’t constantly dropping out of the sky.

When I hear people on the right foaming at the mouth about government meddling in their lives I like to say: “Move to the Sudan - no government, only the warlords to worry about.” This advice works for those on the far left as well. Noam Chomsky doesn’t like limited liability? “Move to the Sudan, buddy - no limited liability there.”

Then once in a while something happens – the global financial system blows up, say – and one begins to worry. Maybe the idiots are everywhere. Just like what happened in Ireland right after the Lehman bankruptcy, as described by Michael Lewis in The Big Short. Many Irish assumed some really smart guy was taking care of the money. Then the country’s financial regulator was wheeled out in front of the cameras, and he sputtered incoherently. The gig was up; a bank run quickly ensued.

Earlier this year, the Bank for international Settlement (BIS) released a paper, written by Stephen G. Cecchetti and Enisse Kharroubi, which argued that when a country’s financial sector grows too large, it hampers rather than facilitates economic growth.

Anyone who makes a living in Hong Kong, a finance town if there ever was one, should be concerned with this finding.

Access to finance is supposed to be good for economies. And the authors of the BIS agree that this is true up to a certain point. But then when the finance sector gets too big it takes resources away from other sectors; and it also does not favour financing unsexy things like research and development, which in the long run enhances productivity.

So say the authors in a paper heavy with equations that helped them pinpoint the phenomenon.

But then just last week a fellow economist, William R. Cline, at the Peterson Institute for International Economics, mocked their methods: “These recent findings warrant considerable caution….because the negative quadratic term may be an artifact of spurious attribution of causality.”

Who talks like that? Anyway, Cline was referring to the quadratic formulae the BIS economists used to measure the size of financial sectors relative to the rest of the economies studied.

Cline employed the same quadratic equation but replaced finance workers with doctors, researchers (R&D) and telephones.

He got the same results –too many doctors and telephones slows growth. “Unless one firmly believes that too many doctors, telephones, and/or R&D technicians reduce growth, one should be suspicious of cross-country regressions showing that too much finance does so.”

Cline’s point is simply that correlation is not causation. He was calling the authors out for using fancy formula to prove a point – the economic version of throwing stardust in the readers’ eyes.

Paul Krugman and Thomas Piketty are among the economists who have done the same, i.e., have attacked their own profession for using fancy equations to prove dubious and politically motivated arguments.

They are basically saying that the profession needs an “It’s not a Buick” moment – to recant the maths-heavy trends of the past 40 years of the profession. Junk it, and create something better.