Economy — Debate

Part of the debate – in the House of Lords at 2:30 pm on 7 May 2009.

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Photo of Lord Plant of Highfield Lord Plant of Highfield Labour 2:30, 7 May 2009

My Lords, like other noble Lords, I thank the noble Lord, Lord Forsyth, for facilitating this debate. I am rather dauntingly aware that I am neither an economist nor a businessman; in fact, I am an academic philosopher. I want to concentrate on one thing in my speech. It is an abstract point, but I hope that it will not be arcane or without interest. I shall concentrate on the value or price of toxic assets or sets of assets that are included under that general rubric—CDOs, mortgage derivatives and so on. This is an important issue, as the banking sector will have to be reformed if it is to play a central part in the economic recovery to which we all look forward. Yet we have grave difficulties in trying to understand exactly how we are to do that without getting a grip on the idea of value or price in relation to some of these more exotic instruments.

It is often said—in a way, it is obviously true—that the last 30 years have seen the triumph of economic liberalism. However, there is a paradox. The development of these assets has been a product of economic liberalism and deregulation, yet those who have lauded the development of these assets have neglected one of the central themes of economic liberalism, which is that value and price are fixed in open markets by the relationship between the buyer and the seller, and value is subjective; it is about the preferences of individuals, whether they are buyers or sellers. However, many of these assets have become detached from any clear relationship to a market in which value understood in that way can be credited to them. Let us take the case of CDOs. They are sub-prime mortgages, which is a bad thing in itself, but then they are divided, subdivided, bundled up and sold in different ways to different groups of people. People have a remote understanding of how that relates to ordinary market transactions.

Many people will say that that does not matter, because the value of these assets can be fixed by mathematical modelling of one sort or another. I heard someone making this claim on the radio last week, saying that we need not worry about the relationship between these assets and normal markets because the value of these assets can be fixed by mathematical financial mechanisms. Anyone who has read, even superficially, the economic liberals will know that a great deal of their thought is characterised by the rejection of those sorts of mathematical models. The reasons for that are twofold. First, people such as Hayek argued that markets are too complex and dynamic for any mathematical model, however cleverly constructed, to capture. The second and perhaps more important point—again made by Hayek and Mises, in particular—is that a great deal of the knowledge that is utilised in a market is not propositional knowledge, which is the only kind of knowledge with which mathematics can deal. Rather, the knowledge that is important in markets is tacit, implicit knowledge; it is knowing how rather than knowing that. Yet you cannot bring into economic models in any straightforward way, if at all, this tacit, implicit knowledge. Economic models require things to be made explicit that are always actually going to be implicit. There are therefore big buffers or road blocks in the way of an ability to produce models of assets that are not traded in a normal market context.

If any of that is true, as I think it is, we are facing the paradox that economic liberalism has been threatened by products that are themselves a product of economic liberalism but have been created in the face of the basic understanding of price and value within an economic liberal philosophy. If, however, it is impossible to bring those assets into relationship with normal market understandings and transactions, we have to do what the noble Lord, Lord Lawson of Blaby, argued earlier, which is to separate out the exotic—the casino, if you like—aspects of banking from the normal, everyday family and businesslike aspects of banking.

If we cannot find a regime—I am not remotely in a position to suggest what it might be—to bring an understanding of the value of these complex commodities into relationship with, as it were, normal understandings of markets, we have to divide those sorts of assets and how they are dealt with in banking and so forth from those assets that we all understand and are part and parcel of normal market activity. Behind this rather esoteric debate about the nature of knowledge lies something very important: you cannot get way from the idea that economic value is subjectively determined in market exchanges, and that cannot be fully captured by economic models, however complicated they are.