The crisis-free economy that has yet to be invented


Ten years after the housing bubble burst, the economic sciences are still battling with reforms, says Marc Chesney. Thomas Bieger, on the other hand, insists that economists are today also taught the psychological and sociological aspects of their discipline. We've interviewed them both. Moderator: Philipp Hufschmid

(From "Horizons" no. 114 September 2017)​​​

Is there a scientific basis for the development of the economy and the financial system? Marc Chesney, professor of quantitative finance at the University of Zurich, believes that economists have failed to integrate ethical aspects and the issue of natural resources. Thomas Bieger, Rector of the University of St. Gallen (HSG), replies: "I'm convinced that we have learnt the necessary lessons".

"Why did nobody see it coming?" asked the Queen of England back in 2008 on a visit to the London School of Economics. Prof. Chesney, should economists have seen the financial crisis coming?

Marc Chesney: Figuratively speaking, it's as if we're driving a car faster and faster as the mists get thicker and thicker, until finally we have an accident. We don't know when it will happen. But as economists, we should have warned about the systemic risks in good time, before the financial crisis. With a few exceptions, we didn't.

How do you see it, Prof. Bieger?

Thomas Bieger: Our economic development has been characterised by the more or less regular occurrence of economic and financial crises. One famous example is the Dutch tulip crisis of the 1630s. The mechanism is always similar: people invest in something – it might be tulips, or property in the case of the USA up to 2007. The higher the prices rise, the more people speculate with borrowed money in the hope of making big, quick profits from their investment. Until the bubble bursts. Though of course everyone hopes that they'll be able to get out in time. There is a deeply human phenomenon behind all this: people want to get rich quick, with little effort. So the financial crisis of 2007 won't be the last one. But it was very big because major, undetected risks were able to accumulate through new, derivative, off-balance-sheet financial products.

MC: All the same, financial crises don't happen according to some natural law. Unlike in an earthquake zone, where you've always got to reckon on an earthquake happening, the financial world can take preventive measures. The financial crisis was also a consequence of excessive indebtedness and the development of a financial 'casino' that got out of control after Bill Clinton repealed the Glass-Steagall Act in 1999. That act, which separated commercial from investment banking, had ensured that there were fewer banking crises between 1933 and 1999. So there is room for manoeuvre for politicians and economists to try and prevent financial crises.

TB: It's true that there were fewer banking crises. Instead, there were oil crises and even property crises, because people placed their 'bets' elsewhere. On the one hand, I believe our task as economists lies in providing instruments to detect crises early and to cope with them; on the other hand, we should also be providing guidance so that politicians, managers and ordinary citizens can contextualise events. There are economists who warned about the coming financial crisis, but they were hardly noticed by the public.
Economics are part of the social sciences, whose predominant paradigm is that of constructivism. In other words, the behaviour of people is not characterised by objective reality but by perceived reality. If the dominant perception is that current economic laws can simply be suspended – for example, if many people believe property prices can rise indefinitely while indebtedness increases – then people hardly take notice of any other opinions.

What lessons do economists have to learn from the financial crisis?

MC: Economists have to recognise that the financial crisis wasn't a purely technical crisis. It was also a crisis of values. I always show my students e-mails from traders, such as Jérôme Kerviel from Société Générale, who made dubious trades for which some of them have had to go to prison. Over the course of their career, they lost all sense of values. In these e-mails, one of them compares himself with Frankenstein, another with a prostitute, while yet another describes himself as addicted to money. As economists, it's our responsibility to talk about values when we teach, not just about prices.

Are prospective economists taught too little about values, Prof. Bieger?

TB: As a direct reaction to the economic crisis, the University of St. Gallen (HSG) and other economics universities across the world asked themselves how they could improve their teaching and research, for example in the context of the Global Alliance in Management Education. We need to take measures on three levels. First, on a technical level, by looking for the reasons for systemic failures and by finding the right regulations for financial instruments. Then we have to achieve a better understanding of the interaction between the different financial markets. At HSG, for example, we founded a School of Finance to this end in 2011. The second level is interdisciplinary. We have to understand the chain of effects running from human behaviour to the markets. For this, we need an integrative way of thinking that goes beyond economics. We are promoting this in St. Gallen in our so-called contextual studies, where a quarter of the lectures are in subjects of the social sciences or the humanities such as sociology or history.

So is the third level about values?

TB: Indeed, we are giving greater weight to personal behaviour and questions of responsibility. For this reason, we've introduced elements into almost every course where the students are confronted with the challenges of sustainability and responsibility. What's of prime importance here is that placing the students in dilemma situations means they can get to know themselves better and reflect on their own behaviour.

How does this work?

TB: For example, we've got a trading area at HSG where we can play through market situations. And we engage in more discussion with the students in case studies – why they made a specific decision in a certain situation, and what the consequences would be if all market participants were to act in the same way. We have assimilated what we were able to learn from the last crisis.

Do you see a need for further action, Prof. Chesney?

MC: For an academic career, publications in the top scientific journals are decisive. In the financial sector, these publications are heavily influenced by the Chicago School and especially by their Efficient-Market Hypothesis. Anyone whose stance is critical of this School has a markedly smaller chance of publishing an article there. The result of this is that young economists tend to choose topics that have a better chance of getting published, so they can make progress in their careers. A topic as important as sustainability doesn't appear in the leading finance journals. So what we need is new, top-quality journals that make a broader variety of topics possible.

Is independent research in danger on account of the compulsion to publish in specific top journals?

TB: Various scientific and scholarly communities put a great emphasis today on having publications in the top journals. Some disciplines are indeed very much moulded by individual publishers or specific networks. Young researchers can't avoid publishing there if they want to get noticed internationally. So my advice is: you should do the one, but not ignore the other.

We've spoken of reforms in institutions. But shouldn't certain theories and models in the economic sciences be scrutinised too?

MC: Yes. Regrettably, there are many models today that have little relation to reality. It is difficult today to justify the assumption that there are risk-free investments that will allow you always to make a positive return. For example, are government bonds risk-free? In Switzerland, their returns are often negative. For a while, that was also the case in Germany and Japan. We should take a good look at what theories and models are still valid and relevant today, and to what extent new concepts have to be developed. That hasn't really been done. If you compare the university lecture lists today with those of 2006, you'll see that very little has changed.

TB: Let me offer another example. It was always assumed that if interest rates drop, then there will be more money to spend, and so consumption will rise. But in fact, in several countries with negative interest rates, the savings ratio is increasing. One hypothesis for this behaviour is that people realise that negative interest rates have an impact on their old-age provision and that they have to save more to make good their losses. That is precisely why an interdisciplinary perspective is important to evaluate economic models – a perspective that meets the needs of people in a comprehensive manner.

After the financial crisis, economists were accused of having failed to develop models for sustainable growth. Is this a topic of debate today?

MC: I don't know of any economics lectures that seriously ask whether growth is absolutely desirable for the total population. Growth at any cost seems to be a dogma. Growth criticism is largely taboo. There are too many economic models that are uncoupled from resource consumption. But we have to challenge this desire for growth and try to develop new models.

TB: The concept of sustainable growth, in which no non-renewable resources are consumed, is at the forefront of all aspects of university education today. And the concept is broadly anchored in our research, too. We have several institutes, such as the Institute for Economy and the Environment, where we research into sustainability. But we also have a responsibility towards the poorer regions of the world, where the population is growing rapidly. In the foreseeable future, they will have a need for growth that will hopefully be sustainable.

So growth criticism is primarily something for an affluent society?

MC: Yes. If you've got to survive on less than two dollars a day – as innumerable people have to across the world – then for them, more is better. But we should at least think about the type of growth we want, and develop other paradigms.

Have the economic sciences learnt enough from the financial crisis?

MC: No, there are no incentives to learn from it.

TB: I'm convinced that we have learnt the necessary lessons from the last financial crisis. What concerns me is that up to now, the post-crisis was always a pre-crisis. And that we still never know where the next problem might arise.

Philipp Hufschmid is a journalist and an editor at the Berner Zeitung.