Adair Turner is the jewel in the crown of British public servants. He is one of a tiny minority in public life today capable of thinking and acting at the highest level. Economics after the Crisis, based on three lectures he delivered at the London School of Economics in 2010, is a thinking person’s delight, not least for the clear and lucid way in which Turner sets out his arguments. His book challenges the three main planks of what he calls the “instrumental conventional wisdom”. The first is that the object of policy should be to maximize Gross Domestic Product per head; the second, that the primary means of doing this is to create freer markets; the third, that increased inequality is acceptable as long as it delivers superior growth. The attack is devastating, leaving little of the policy edifice of the past thirty years standing.
The case against making increased GDP per capita the overriding policy objective is that it doesn’t deliver the increased happiness or welfare if promises. In 1974, the economist Richard Easterlin published a famous paper, “Does Economic Growth Improve the Human Lot?”. The answer, he concluded, after correlating per capita incomes and self-reported happiness levels across a number of countries is probably “no”. In a refinement dating from 1995, Easterlin found no relationship between income and happiness above an average per capita income level of between $15,000 and $20,000. Other findings confirm Easterlin. Data from the UK show that from 1973 to 2009, there was a continuous rise in GDP per head, but no increase in reported life-satisfaction. What is more, some of the “happiest” countries are also the poorest. However, inequality within countries does matter for happiness: the rich in the UK are on the whole happier than the poor.
Why, above a quite low income threshold, does a person’s happiness not increase with more income? The intuitive explanation must be that rising incomes produce dissatisfactions which offset the pleasure which the increase affords. Turner discusses some of the ills of wealth. The richer societies are, the more “status” goods people want, but because status is relative there is never, so to speak, enough of it to go round. The same is true of “positional” goods. “If the supply of pleasant homes is restricted then you have to seek to win in the relative income competition.” But there are only a few winners. Growth in wealth also worsens the environment, thus degrading the benefits it seems to make more generally available.
These negative effects of economic growth on contentment levels are well known. More radical is Turner’s attack on our way of measuring wealth. GDP measures the volume of marketed output, not its quality. But it is the improvement in quality which is chiefly important for satisfaction. Taking his cue from the economist Roger Bootle, Turner argues that a large fraction of GDP, especially in finance, law and “branding”, measures “distributive” rather than “creative” transactions; that is, it measures transfers between groups and individuals rather than net additions to income. “The clever lawyer who wins a case for his client achieves a redistribution from the opposing client but doesn’t create greater social value.”
Inequality within societies does matter for happiness, however. Studies show that, in any society, the rich are happier than the poor, and that at the same average income levels, more equal societies record greater levels of happiness. This throws the onus of increasing welfare or satisfaction on distribution. But modern capitalist society, especially in its Anglo-American version, produces growing inequality: over the past thirty years the very rich have pulled away from the moderately rich, the average from the median, and the median from the bottom. Why have the rich gained and the poor lost ground?
Turner’s explanation is twofold. On the one hand, the world of stars and celebrities created a momentum towards excessive rewards untrammelled by former considerations of what was reasonable and fair. On the other hand, technology and globalization have forced down the wages of the least skilled. For all these reasons, Turner believes that “there is no good reason for believing that additional growth in average income, as measured by by national accounts, necessarily and limitlessly delivers happiness” (my italics) and that “rich countries are now in a zone where further increases in average happiness are of uncertain and in some respects of diminishing importance”.
Turner’s second target is the belief that freer markets are the best way to produce faster growth. Evidently, if faster growth is no longer so important, “freeing up” markets is less important too. But Turner argues that the proposition that freer markets bring faster growth is not true in any case. The empirical case is shaky, the theoretical case deeply flawed. Before the First World War the United States achieved rapid growth behind high tariffs. China has been stunningly successful with an eclectic economic system. There is no evidence that the growth of rich countries accelerated following extensive market deregulation in the 1980s.
The theoretical case goes back to Adam Smith: the wider the market, the faster the growth of wealth. The argument, applied to the financial markets, is that the more “liquid” they are, and the more extensive financial innovation is, the more efficient the economy will be. This was the conventional wisdom Turner experienced first-hand as a banker and as chairman of the UK Financial Services Authority. Professors of finance like Eugene Fama gave it authority by claiming that all risks would be correctly priced, so that current prices would always reflect fundamental values. Regulation should be confined to specific “market imperfections”. This wisdom, Turner asserts, was part of the “institutional DNA” of Britain’s Financial Services Authority in the years before the crisis.
The so-called efficient market hypothesis overthrew the previous consensus established by John Maynard Keynes, and reinforced by Hyman Minsky, that because the future was inherently uncertain – that is, because no objective probability distribution of future outcomes exists – many risks could not be correctly priced, and that consequently the financial sector was a potent source of instability, which needed to be extensively regulated. Minsky argued that booms and busts were inherent in finance capitalism, since a stretch of good economic times will shift the balance of financial activity from investment to speculation, which ends in sudden crashes and economic collapses. This “financial instability thesis” suggested a strong role for government in regulating the banking sector and offsetting, through monetary and fiscal policy, any tendency for the economy to deviate from a stable growth path.
Turner notes, without entering deeply into the arguments, that economists have used three main intellectual strategies to explain why financial markets, contrary to the financial efficiency thesis, do in fact exhibit cycles of boom and bust. The first is that human behaviour is partly irrational: herd behaviour has evolved as an essential strategy for human survival. A second strategy emphasizes imperfect information as the source of less than perfect market outcomes. But the strategy chiefly favoured by economists of a neo-liberal persuasion is to blame bad market outcomes on government interference or incompetence. This explanation was much invoked at the time of the East Asian financial crisis of 1997–8. It was revived to explain the banking implosion of 2007–08 and the feebleness of the subsequent recovery.
One undoubted result of financial liberalization has been a very steep increase in the relative scale of financial activities within the economy, and a big increase in financial-sector remuneration relative to that of the non-financial economy – one of the main drivers of inequality. This leaves defenders of the free market unfazed, since they argue that increased rewards to the financial sector merely reflects its greater “creativity”. Turner counters convincingly that this ignores the power of the financial sector to extract “above normal” returns and the lack of a physical “product” in the traditional sense against which the value of financial services can be measured. This gives finance unrivalled opportunity to extract distributive rents from the rest of the economy.
Turner’s conclusion echoes his oft-quoted remark that a large part of financial activity is “socially useless”. He throws out the interesting suggestion that at an earlier stage of economic development, financial liberalization stimulates growth and widens the range of choice available; but later in the development process, the last additional unit of financial liberalization is “less likely to deliver increments in growth and more likely to produce the proliferation of rent-extracting opportunities”.
Turner’s most radical suggestion is that rich societies should abandon measured economic growth as an overt object of economic policy
Finally, Turner considers the implication of his findings for economic policy and theory. His most radical suggestion is that rich societies should abandon measured economic growth as an overt object of economic policy. This is because it is no longer of “overriding importance” for them. He is not against economic growth as such. It remains instrumentally valuable in many situations: it is good for low-income countries; it can deliver well-being even to rich countries, by, for example, increasing the resources available to health-care; and it can make it easier to redistribute resources to the poor in rich countries.
Economic growth is also likely to result from the pursuit of economic freedom and full employment which Turner does regard as valid policy objectives. Economic freedom is valuable because economies may regress without it (the Soviet Union is an example), because valuable human activities require the motive of money-making and environment of private ownership (here he echoes Keynes); and because expectations of improved products which economic freedom brings can be important to our sense of well-being, even if no permanent increase in happiness results.
But economic freedom is not enough. The continuous improvement in productive efficiency which it promotes leads to growing technological unemployment as existing jobs become redundant. So macroeconomic policy should aim at maximizing stability and minimizing downturns: the classic Keynesian prescription. The same logic of minimizing the downside of economic freedom rules out a laissez-faire approach to climate change. The possibility of catastrophe, however small, needs a radical reduction of carbon emissions now, even if the costs are considerably higher than the private sector would want to pay. Economic freedom should also be limited to prevent public bads like congestion and pollution.
Finally, population should be stabilized to reduce competition for positional goods – goods like Old Masters or beautiful views – that only a few can get, whatever the average level of income. “If the British population stabilizes through some combination of a lower birth rate and lower immigration, aspects of that competition will become less intense.”
Turner raises two further issues that economics can’t resolve. Economics can’t tell you which forms of consumption are better than others, and it implies that policy should not seek to do so either. But this would be true only of perfect markets and rationally self-interest individuals. We know that in practice, individual preferences are deeply influenced by fashion and advertising; and that many goods and bads do not enter into individual cost-benefit calculations. An omniscient paternalist might devote more consumption to resources that produce healthier and longer life and seek to limit the harmful effects of poor individual choices. But this would require more taxes and restrict freedom. There is no magic answer, only a “continual process of political debate about whether and how we might influence the allocation in a more favourable direction”.
Secondly, Turner rightly rejects the mainstream view that commitment to economic growth requires the level of income inequality that has grown up in recent years. The idea that incentives to work require lower taxes is “hugely exaggerated”. Small differences in top pay make little difference to how hard people work. But he concedes that, beyond certain levels of tax, issues of international competition become important, and tax avoidance activities will proliferate. So there is no easy answer to the unavoidable question of what is “fair”.
At the end of his book, Turner endorses the case for the “reconstruction of economics”. Conventional economics, by playing down the severity of market imperfections, has sanctioned a modern version of laissez-faire which not only inflicts huge short-term losses through periodic economic collapses, but supports an economic structure inimical, in many ways, to long-term human welfare, in the name of a market perfection which is unattainable.
The principles of such a reconstruction are clearly set out. Economics should draw its arguments from the world as it is, not from a model of perfect markets. It should not attempt to achieve one all-encompassing theory of behaviour. It should not assume that people in financial markets make rational assessments of future probabilities of potential outcomes, but seek to establish how they actually make decisions under different conditions. It should take on board the existence of Keynesian/Knightian uncertainty (following Frank Knight’s definition of immeasurable risk). It should include history. And it should recognize the importance of political, philosophical and ethical issues to which mathematics is incapable of giving precise answers.
An author who is so continually thought-provoking will expect some dissent. Turner wants us to think of economic growth not as a policy objective, but as an “acceptable consequence” of economic freedom. This may be so, but, as Turner himself acknowledges, economic freedom itself “needs to be balanced against other potentially desirable objectives”. For example, an expansion of leisure (which most people would regard as a good thing) might result in negative growth. Whether a healthy economy favours growth or not is an empirical question; it cannot be assumed a priori that a growing economy is a good economy.
Turner is rightly sceptical of the argument of economists like Richard Layard that happiness is the sole good. (The King of Bhutan has proposed to replace GDP with “Gross Domestic Happiness”.) Suppose people are made ecstatically happy by the human sacrifice of a tiny minority. Would we want to say that such a state of mind – or its resulting state of affairs – was good? Clearly not, Turner thinks. Throughout the book, however, he uses terms like happiness, welfare, well-being, contentment, satisfaction and utility synonymously. This undermines the force of his criticism of the “happiness” economists, who can point to empirical correlations between, say, happiness and equality. Taking happiness as the sole good may lead us away from treating growth as the main objective, but it does not inescapably lead us towards the good life. This is the argument against happiness economics that my son Edward and I have developed in our book, How Much Is Enough?: The love of money and the case for the good life, published earlier this year (reviewed in the TLS, July 13, 2012).
Finally, Turner follows Keynes in his belief that ideas are more powerful than vested interests. This leaves him without an explanation of how certain ideas (those he attacks) came to dominate both the economics profession and the policies of governments and regulators in the thirty pre-recession years. At heart, Adair Turner is a Mandarin, who believes that intelligence can tame power. Some punches in the book are pulled, some arguments fudged, probably in order to preserve his future employment in government service. If this is his personal Faustian bargain, who can blame him for it?
Robert Skidelsky is Emeritus Professor of Political Economy at the University of Warwick. He is the author of a three-volume biography of John Maynard Keynes (which appeared in one volume in 2005), as well as two more recent books on Keynes: Keynes: The return of the master, 2009, and How Much Is Enough?: The love of money and the case for the good life, co-written with his son Edward and published earlier this year.