Sunday, 7 April 2013

Very simple thoughts about the politics of crisis

I am not nearly good enough at macroeconomics (and probably not clever enough) to understand the economic crisis itself. Here is how I think about the politics of it.

The world contains a huge variety of human interactions. One simple way to classify them is: some are games of decreasing returns and some are games of increasing returns. Suppose many people can do more or less of something -- say, withdraw more or less money from a bank, or spend more or less time looking for work. In a game of decreasing returns, when other people do more of it, you will gain by doing less. In a game of increasing returns, when others do more, you will gain by doing more too.

Most ordinary economic activities are of decreasing returns. If many other people go into cheesemaking, the price of cheese will go down and you might wish to choose a different career. If Turkey is this year's cool holiday destination, then it's going to be expensive -- why not try Greece? Decreasing returns are self-equilibriating, like one of those toy men you can't push over. There is only one equilibrium, and this makes life cognitively easy. For example, prices will naturally guide you to optimal decisions, and prices will change only a little bit when underlying conditions change.

But there are some activities which are naturally of increasing returns. Starting a revolution, or fighting in a battle, is easier if everyone else is trying to do it simultaneously. If others take their money out of the bank, then you should beat them to it before the bank goes bust. Life in increasing returns land is hard, because there are multiple equilibria. If everyone else is doing it (whatever "it" is), so should you; if not, not. Getting it right takes not just individual effort, but also the ability to coordinate and communicate with your fellow players. That is especially important when one of the equilibria, such as a bank run, is definitely bad.

My explanation of increasing and decreasing returns. Equilibria are yellow blobs. Art is not my strong point.

It is, and should be, a great goal of economic policy to keep us in decreasing returns world as much as possible. But sometimes -- especially given modern banking, but also because intergroup conflict is a perennial possibility -- we will find ourselves in the other, scarier world. Being in that world, as I said, puts a premium on the ability to coordinate -- that is, to work together: to trust our leaders, and to find our fellow players predictable.

In decreasing returns world, nationality and culture don't matter; simpler mechanisms substitute for them. In increasing returns world, nations matter, because they are the central ways humans have of organizing themselves to act collectively. Culture matters because it is the medium by which we can share and harmonize our expectations with others. When we move into this world, suddenly it matters whether we are Germans, Greeks... or Europeans. That is why the dream of a borderless market, without a society behind it, is a utopia.