A staggering omission

One of the remarkable omissions from much current economic debate in Australia is the role of technological innovation.

The Abbott Government and business focus on industrial relations, tax, debt, deficits and just about everything other than innovation when they talk about economic growth. When they do talk about research it is more likely to be how to cut funding to not only pure research but also applied research as well.

With the Abbott Government it’s probably not that surprising as they generally appear to be anti-science particularly when it conflicts with their ideological views on issues such as climate change and renewable energy. Abbot educational initiatives are also more likely to be driven by the culture wars than by the need for more STEM graduates.

There is the odd mention of innovation in media economic commentary (Ross Gitttins being, as usual the most honourable exception) but generally this is dwarfed by the coverage given to debts, deficits and business bleatings about ‘reforms’ which benefit them while disadvantaging others (like employees) and business oppositional onslaughts against real reforms which might disadvantage business (getting rid of billion dollar subsidies or ridding the financial advice industry of appalling misbehaviour).

It is particularly odd given the work of one Nobel Prize winning economist, Robert Solow, who won partly because he worked out that increases in capital stock and employment were responsible for only about 10% of long-term growth. The rest, he concluded, was due to technological innovation. A good discussion of some of the contemporary relevance of this can be found in Alan Beattie’s Weekend FT article (11/12 April 2015).

Tragically, however, much of the talk about innovation in Tony Abbott’s ‘Anglosphere’ world in recent decades has been in the financial services industries. And the history of innovation there is one where the evidence about malfeasance, incompetence and ineffectiveness continues to mount.

A 2014 paper, Evaluating Trading Strategies, by Campbell Harvey and Yan Lui in the Journal of Portfolio Management concludes that: “Most of the empirical research in finance, whether published in economic journals or put into production as an active trading strategy by an investment manager, is likely false. This implies that half the financial products (promising outperformance) that companies are selling to clients are false.”  The Buttonwood column in The Economist (21 February 2015) explains the reasons quite succinctly. Buttonwood also points out how to make the perfect investment offer – based on the old racing tipster approach to selecting winners. Each week you send out a prediction on a share price. If you send out 100,000 tips (half saying the price will fall and half saying it will rise) and repeat the process only with those who got the successful recommendation for 10 weeks by the end of the period the statistics suggest that 98 people “will be convinced of the manager’s genius and ready to entrust their savings”. As Buttonwood says: “…..this is a classic example of the misuse of statistics. Conduct enough tests on a bunch of data – run through half a million genetic sequences to find a link with a disease, for example, and there will be many sequences that appear meaningful. But most will be the result of chance.” This back testing process, is of course, the basis of the modelling for many trading strategies. With the racing tips scam the starting point is a bit more complex but the principle is still the same.

There is lots of other serious thinking about the inherent problems in financial services. The blog’s friend John Spitzer recently sent it a copy of a Science magazine book review (Science 28 November 2014) of a new book, Capital Failure, which is the product of a year-long series of meetings and seminar’s organised by Oxford University’s Nicholas Morris and David Vines which brought together people from various disciplines to discuss financial accountability in the financial services industry. Significantly the book reviewer is another Oxford academic, Robert M. May, from the university’s Department of Zoology which the blog thinks is an indicator of the sorts of skills which are probably best needed to analyse the industry. Indeed, one can imagine someone equipped with suitable qualifications engaging in a lengthy discussion of how the primitive amoebas crawled from the primeval slime and rose to become masters of the universe – without ever shedding the slime. However in the book the chapters are more mundane ranging over the history of banking crises highlighting their frequency; corporate governance; misallocations or risk and reward; and the ethics of those such as the Goldman Sachs staff who marketed investments to clients and then promptly took short positions in the recommended investments.

But it all prompts one to think that in Australia we could perhaps have a year of government-sponsored meetings and seminars on the role of technological innovation in ensuring our long-term economic future. At the same time we could, in less than a year, implement some rapid reforms which would stop financial services companies ripping off punters with dodgy products, practices and financial innovations.