Sunday, 13 February 2011

The Art of Pragmatic Economics

Last week a few friends of mine went to see a lecture by the legendary Donald Knuth.

Knuth is famous for three things (at least three things):

  • Not finishing a book series - the seminal Art of Computer Programming. First started in 1962
  • Refusing to write real cheques due to bank fraud
  • The phrase 'Beware of bugs in the above code; I have only proved it correct, not tried it''

All of which I thought were very appropriate to the general state of the world economy - paralysed like the early medieval congregations convinced by endless repetition of incorrect doctrine that the world would end in 999AD.

The alternative approach is rational and pragmatic. The pragmatic approach emphasises getting something useful done that might just benefit people based on the current available evidence, but in a way that acknowledges that you don't know everything and you might have to back it out. It handles edge cases as part of the method rather than obsessing about them to the exclusion of the useful 90%. It uses tight feedback to keep areas of concern under control.

So rather than worrying pointlessly about edge cases, about the relative risks of hyperinflation, whether there are real or budget constraints or the theoretical direction of causality, why not do something pragmatic that takes what we know and don't know into account?

Concentrate instead on the central policy change that makes all the difference.

Instead of

'what are you going to cut to fund programme X/tax cut Y[1]'

you can have:

'fund programme X/tax cut Y[1], which will either pay for itself by expansion in the real economy (in which case inflation will stay steady and there will be no compensatory tax/interest rate[1] rises), or it won’t (in which case this tax/interest rate[1] will change).'

(1 - delete as applicable depending on political prejudice/religious belief[1]).

In other words the policy options switch from ‘pre-fund’ to ‘post-fund as required to maintain stable prices’. Taxation is no longer linked rigidly to the amount of government spending, but to the combination of government spending, net private sector nominal saving and the real expansion of the economy.

It is powerful to be able to say “We intend to introduce a Job guarantee scheme funded by the state and we expect that the economy will be able to expand its output to absorb this extra spending. However we reserve the right to increase Corporation Tax by up to 3% to compensate should it feed through to demand inflation. Obviously we want to avoid that so over to you Mr Entrepreneurs to create the necessary economic expansion.”.

It's pragmatic, it provides a clear incentive backed with money and it targets help at real people who are suffering today. They simply can't afford to wait 50 years for the theory to get worked through accurately.