14 – The Elephant, Blind Men, and the Rhinoceros (11 Feb 09)

    The credit crisis and what follows, dominating economic discussions for some five months now, have prompted such a variety of explanations of causes and remedies, that I keep thinking of the famous Hindu and Indian Buddhist parable of the six blind men and the elephant. One feels a leg, another the trunk, and yet another its tail, and they all come with stories challenging each other’s truth. It would be hard to find a better recent instance of what the fable depicts. I have just re-read some contrasting explanations: from Clintonian regulations perverting private incentives, to Greenspan’s supporting the kind of activity and deregulation schemes that eventually made the crisis possible. Too much regulation, too much de-regulation, the housing market gone wild, and technical change, are among the essences brought forward by the explicators. Their explanations can roughly be grouped under headings of pure theory, historical analogy, empirically informed speculation, and, not to forget, a lot of self-interest.
     These categories overlap with two main cross-sectional divisions. It would seem that the most popular explanations among the culprits and their colleagues inside the financial institutions have revolved around deteriorated morals: excessive greed, bad apples, and so on. The advantage of this take is that it ultimately justifies preserving as much as possible of the institutions and methods that brought the crisis about. Left-leaning analysts, however, tend to speak of structural causes, reminding us that greed on behalf of their corporations constitutes a fiduciary obligation for capitalistic managers, especially in a deregulated capitalist environment. The clashing explanations reveal which certainties are in play, and where the shoe pinches most for people in different niches of the political spectrum. They also reveal, once again, the strong ideological content of American economic and political thought. Early in the crisis, explanations as to what we should expect to happen next tended to lead to pitfalls of historical analogy. Because consensus had declared it the greatest economic calamity since the Great Depression, it had to be similar to the Great Depression in important ways, and editors and TV commentators kept on obsessing about the immediate behavior of stockmarkets having gone wild because of speculative trading.
     As we all know, analogies exist to create an understanding of things not yet fully grasped. Less well-known is that if your analogies are based on projections of your own obessions on to the situations in other countries you are going to delude yourself with misunderstandings.
     A favorite comparison has been with the “bubble economy” of Japan and its aftermath from 1990 onward. And with that we are in the presence of blind men who have been told that they are examining an elephant, but who in fact are blindly fumbling a rhinoceros.
     In one among plenty of examples I just came across, two specialists working for the IMF talk about lax financial regulation in their first line. But Japanese banks are not “regulated” in the common understanding of the term, they operate under signals of the finance ministry. It was through these signals that they had changed their lending practices, which brought about the bubble. The authors picture a government struggling with orderly deleveraging while limiting moral hazard. But moral hazard implies a consciousness of risk and the conviction that someone else will bear it. Japan’s banks never acted as if they were at risk (at least not until much later in the mid 1990’s), and the ministry did not want them to act as if they were at risk. The IMF document speaks of a Japanese strategy in the aftermath of the bubble, but the officials did not know what to do and the country was operating on autopilot. We are told that when the crisis intensified, the authorities turned to restructuring banks, pushing them to recognize problem loans. But the financial supervisory agency was telling banks not to recognize problem loans, as the authorities did not want important zombie companies to collapse. The ministry sponsored and ordered shotgun mergers of the banks, but real decision makers were not replaced.
     The article does not begin to give an accurate picture of what happened financially in Japan as the bubble deflated. But it is a bit unfair to pick on them, as they are merely repeating uninformed comment on the Japanese crisis that is the rule rather than exception.
     What appears lost from view in practically all comparisons between the American and Japanese bubbles is what caused the one in Japan to begin with. In Japan the spiral of real estate and share prices reaching incredible heights served the purpose of providing costless capital to manufacturers with which to expand and streamline their production apparatus, so as to recover their ability to turn a profit in export sectors. The near quadrupling of the value of the yen against the dollar in two decades had made that necessary in the eyes of government officials. They set it all in motion by encouraging banks to expand their lending on very favorable terms beyond the circle of politically well-protected firms. There was more to it than that, of course, as the best treatment of this episode by Murphy and Mikuni lays out.
     There were some individual speculators and smaller corporations that the exercise had not meant to be included, making loads of money and subsequently losing their shirts, but from what I remember of the estimates at the time these took care of only some ten percent of the relevant transactions. At the end, and after the greatest wave of plant and equipment investment in human history, the manufacturers still had the vastly improved production machine.
     The Japanese authorities and their counterpart administrators in what is in Japan also (but misleadingly) known as the private sector, did lose partial control in the end, but the bubble never “burst” in the way one made of soapy film does. A better metaphor would be that of the gradual deflation of a rubber balloon. They should have done it earlier, and the fact that world demand for the products coming off the newly built and streamlined conveyor belts had sunk to new lows in the early 1990s did bring huge problems, but this was not a familiar tale of corporate and managerial “greed”. No Japanese executives were lining their own pockets.
     An obvious question is why intelligent economic commentators, even those who spend time in Japan, have appeared oblivious to what I am saying here. An important part of the answer is that Japanese reality does not fit conventional wisdom. The questions prompted by prevailing economic theory do not lead to the necessary insights, and people whom economists residing in Japan report to would not be able to make sense of the anwers prompted by the right questions. Some economic specialists whom I admire may record accurately what Japanese officialdom has done, and still miss crucial points as they do not question the general assumption of mainstream economists that Japanese and American or European incentive structures are the same.
     So Japanese economic reality, although well recorded in bits and pieces, is not properly observed by most experts. What to make of that? Japan is still the world’s second largest industrial power (if we do not count the European Union as one unit) and it is not, like the backside of the moon, permanently beyond scrutiny for us. Those around the elephant charged with plotting an escape from our current crisis might do well to get to know their animal better by comparing it to the rhinoceros.
     You would think that specialists with a task of finding solutions, or at the least remedies that limit the damage, would want to make use of the accumulated knowledge of human experience as fully as possible before taking further steps. The Japanese economy and the way in which it is intricately embedded in a political system is, without question, part of the human experience. An understanding of economic reality writ large, and the various possibilities of economic organization, could help get us get out of a conceptual cage. What sort of persuasion does it still take, in the midst of the current collapse of global finance, to see that the specialists and those who do the reporting are confined in a conceptual cage?
     What is happening at the moment to the organization of that part of our material world linked to money is so dramatic that a way must be found out of that intellectual dead end through conceptual jumps. A few economists appear capable of accomplishing this. Fortunately. James Galbraith just showed us how make several such jumps. Supported by tight analyses in his The Predator State, he argues convincingly that American conservative business elites and linked interest groups do not want to do away with the state, as is commonly assumed to be their wish, but that the most powerful among them have managed to capture the state for their own purposes of long-term enrichment and greater power. After going through Galbraith’s intellectual tour-de-force, with its priceless passages on what, in practice, that sacred entity known as the market comes down to, it is unlikely that you will conceive of state and market in the way you have until now.
     A comparison of the predator state with the dirigiste economic system of Japan could offer a wealth of insights on incentive structures, and, who knows, perhaps how to bend these for finding a way out of our current dilemmas.