August 2009 – ManageWithoutThem

ABC radio’s PM programme has a good little interview with Jim Standford regarding how people incorrectly think of economics as part of the finance industry rather than the finance industry being just a part of the economy:

JIM STANFORD: … I mean the financial sector is a part of the economy but it’s not the most important part of the economy. In fact in many ways it has very little to do with what the true economy is about, which is about average people getting up, going to work, producing something useful, a good or a service that has inherent value, and then how we pay people for it and how they buy stuff.

…

JIM STANFORD: I think that this meltdown in some ways is the culmination of say three decades or so of a trend where we glorified finance, we privileged finance, we even subsidised finance through a tax system that favours paper investments over real production. And we came to equate the ups and downs of the markets with what the real economy was all about and that was wrong.

The financial sector doesn’t produce anything of real value in and of itself. It is supposed to facilitate investment and growth in the real economy but it ended up serving its own purposes. It became the tail that wagged the dog and as a result of 30 years of over-financialisation we had this inevitable breakdown and now we’re all paying the price.

A brief, but interesting introductory article on the types of accounting rules that are legal but which promote bad investment in the long term appears here (pdf). The summary, in the form of a joke, follows:

Three accountants interview for a job. When asked to evaluate 2 plus 2, the first responds “four,” and the second, thinking it’s a trick question, says “five.” But the third, whom they hire on the spot, says: “what do you want it to be?” I wasn’t laughing, however, when I learned that the behavior of candidate three lies within generally accepted accounting practice.

The article provides an example of the “trouble [that] can arise when single numbers are substituted for distributions.” But I think there is likely to be a more general explaination of the problem. Also, as the article sights there is the general problem of:

…But when they need to estimate the NPV of a project for an accountant, they will inevitably be asked for a number.

I can’t help but think this is an example of the ‘bad math’ that Chris Macrae keeps mentioning in his more lucid moments (1, 2, 3) when he say, for example here:

about 10 year ago … in big management consultancies through the 90s I was appalled at a maths error that was systematically devaluing trust, rewarding those who imaged over reality including conflict-makers and short-term speculators -the so called Unseen Wealth Intangibles crisis as it was then called, the Inconvenient Truth crisis as some sustainability mapmakers now call it. (typos corrected from the original quote)

Somewhere in all of this there is a lesson to be learnt from economics and the need to look beyond the short-term to the long-term impacts of the rules within systems.

Month: August 2009

“We glorified finance, we privileged finance, we even subsidised finance”

Bad maths, accounting, and risk management