Can failure really be a spur to success? By Tim Harford and Emma Jacobs
First published in FT Magazine 4 June 2011

One June evening in the summer of 2002, the Shubert Theatre in Chicago played host to a new ballet/musical, Movin’ Out. The show was an unlikely collaboration between Twyla Tharp, a dynamic and challenging choreographer, and the songwriter Billy Joel. It was scheduled to open on Broadway that October, but the critics hated it, offering reviews varying from “stupefyingly clichéd and almost embarrassingly naive” to “pile-driving and ill-conceived”.
So enthusiastic was the criticism that the New York paper Newsday broke with tradition to reprint one of the choicer reviews, well in advance of the Broadway opening. It was left to Twyla Tharp, who had dreamed up the project and directed and choreographed it, to somehow fix the multi-million-dollar mess.
Tharp’s experience, as related in her book The Creative Habit, exemplifies the textbook response to failure: she took the criticism on board, made the necessary changes to her show, and opened on Broadway to glowing reviews. The show won two Tony awards, one for Tharp’s choreography.
The story of Movin’ Out is striking not just because it offers an inspiring narrative of adversity and triumph, but because this sort of transformation is unusual. The idea that one should bounce back from failures is an old one. King Robert the Bruce’s eventually successful war against the English is said to have been inspired by a persistent spider spinning a web in the cave where he was hiding. This was eight centuries ago, yet suddenly the idea seems fashionable – perhaps because there is a lot of failure to go round these days.
In the abstract, learning from your mistakes is an easy and uncontroversial idea. In practice, the whole, facile concept is shot through with difficulty. Who is to say that a mistake has been made? Are the lessons to be learnt really so obvious?
We approached public figures – entrepreneurs, artists, politicians and, of course, bankers – associated with spectacular setbacks of one form or another, asking them to explain what effect the failure had had on them. There were few takers, and one of the refusals – from the former chief executive of a failed bank – was particularly colourful. It seems that these redemptive stories of “learning from mistakes” are less inspiring from the wrong end of the steamroller.
. . .
Put yourself in the shoes of Gerald Ratner. Two ill-judged jokes about his jewellery empire, and it had gone. Ratner says he learnt nothing from this. At first that seems outrageous – but on reflection it is hard to see what he might have been expected to learn, beyond the narrow fact that he shouldn’t sneer about his own products in public. His later, more modest, success with a chain of health clubs didn’t reflect the lessons he had learnt but his proven gifts as an entrepreneur, and they had been there all along.
Twyla Tharp learnt more from her failure in part because she was operating in an environment designed to allow that learning process. The out-of-town tryout is a well-established theatrical institution, and there is an honourable history of rewrites in musicals. (A Funny Thing Happened on the Way to the Forum was first staged, unsuccessfully, without its opening number, “Comedy Tonight”.) Tharp masterminded a more profound and successful transformation of her work than is usual, but this is a difference in degree rather than a difference in kind.
Prototypes – the pre-Broadway run; the focus group; the beta release – are an essential business tool. But they would not have saved Gerald Ratner’s empire, and there are many situations in which prototyping simply cannot help. What exactly is the right way to test a safety system in a nuclear power station, for example? Or, for that matter, a credit default swap on a package of subprime loans? (In fact, nuclear power stations make extensive use of simulators to train their operators – a good idea, but only as good as the simulator itself.)
An important principle of safety engineering, now making its way into banking regulation, is to decouple a complex system so that small parts can fail without destroying the whole. This is wise but it is not always easy. If the mistake is catastrophic enough, learning lessons will be futile.
Ernst Malmsten, the co-founder of Boo.com, a notorious dotcom flop, has reached the conclusion that sometimes it’s not what you do but whether you do it gradually or at a gallop. Boo.com was a fashion retailer, but the manner of its collapse foreshadowed the likes of Northern Rock: the proximate cause of its implosion was the sudden refusal of lenders to back its aggressive business model. There was no off-Broadway tryout here: Boo launched on a grand scale with an expensive 3D website that was way ahead of what surfers on dial-up lines were ready to view. Modest errors in the design of the site were magnified by the ambitious scale of the launch. Malmsten says he has learnt to take things slowly.
The interviewees on this page had one thing in common: their woes became impossible to ignore. Ernst Malmsten watched financiers suddenly pull the plug; Ratner’s gaffe was hurled back at him by the newspapers; Lucy Prebble got to read the obituary of her play in The New York Times, “factitious, all show (or show and tell) and little substance” and the show folded shortly afterwards. Twyla Tharp, too, could hardly deny the message of the critics.
Of course, a person who vehemently denies that he failed is hardly likely to agree to a newspaper interview on the subject of that failure. There are exceptions: witness Donald Rumsfeld’s “Lunch with the FT”, in which he briskly justifies the botched invasion of Iraq, dismisses the missing weapons of mass destruction as bygones, and waves away criticism of his management style (“I don’t give it a lot of credence”).
Rumsfeld is a fascinating character in the study of failure. His refusal to listen to warnings from his own generals – well documented in histories of the Iraq war such as The Gamble and The Fourth Star – is striking. In one infamous press conference, near the height of the insurgency in Iraq, he took the Orwellian step of forbidding his most senior general, Peter Pace, to use the word “insurgent”.
. . .
Yet Rumsfeld’s powers of denial are not terribly unusual. The social psychologists Carol Tavris and Elliot Aronson, authors of Mistakes Were Made (but Not by Me), explain that we are easily sucked into a cycle of self-justification. Once a detective has made up his mind about a guilty man, or a chief executive has set out a bold new strategic direction, contrary evidence is highly discomfiting and will often be rejected out of hand. This “cognitive dissonance” can be extremely powerful, and some of the resulting miscarriages of justice described by Tavris and Aronson beggar belief. When DNA testing was introduced, several prosecutors were confronted with evidence that the semen found on the body of, say, a murdered rape victim did not match the DNA of the man they’d put behind bars. In some cases prosecutors went through extraordinary contortions to explain how this state of affairs might have arisen – rather than accept the painful but overwhelmingly likely conclusion that they had made a mistake.
Tavris and Aronson also reinterpret Stanley Milgram’s notorious “obedience” experiment, in which Milgram’s subjects often showed themselves willing to administer apparently fatal electric shocks. The experiment is usually interpreted as showing that some people will do anything if an authority figure tells them to do so. But there is something else going on: the shocks were very gradually increased in intensity from trivial to dangerous. There was no obvious point at which an experimental subject would find a reason to refuse to continue, because each new shock was similar to the previous one. Tavris and Aronson point out that the moment of quitting is also the moment of recognising that the previous shock had been a mistake. It is very hard to admit such an error to ourselves – we would rather repeat it, in an act of self-justification.
The everyday rituals of life are carefully designed to ensure that people experience the painful sensation of failure as rarely as possible. Think of that trustworthy tactic of office life, the “praise sandwich”. The praise sandwich is a criticism made palatable because it is concealed between two scrumptious slices of praise: “I think this is really good, creative work. It would be wonderful if you could [insert important feedback here]. But overall, as I say, it’s really very good.”
The praise sandwich works because of what the behavioural economist Richard Thaler calls “hedonic editing”. Because losses are far more painful than gains, it’s worth bundling losses together with larger gains – if I receive a tax refund of £150 but lose £10 in the street, hedonic editing is the process of rolling the two together for a net £140 gain. The praise sandwich deploys the same principle: it allows people to save face. Yet as a feedback technique it is risky: the sandwiched-between praise may be lost in the whole. You say, “It’s excellent, but you need to fix …”. I hear “It is broadly excellent”. I feel better, but I will not become better. This will not do, but what is the solution?
There are some people who seem to have an unblinking ability to analyse their mistakes and learn from them. Most of us are not in that category, however. General David Petraeus, celebrated for his achievements in Iraq, was notorious as a young officer for being unable to admit that he was ever wrong: it was the dark side of a brilliant, indefatigable perfectionism. But in 1981, one of the young Petraeus’s first commanders, Major General Jack Galvin, installed Petraeus in the role of official critic. “It’s my job to run the division, and it’s your job to critique me,” insisted Galvin over Petraeus’s protestations. Galvin well understood that not only can we not afford to ignore criticism, we must often go out of our way to solicit it.
Gerald Ratner’s experience is revealing here. Before he gave his fateful speech to the Institute of Directors, he consulted the public relations expert Lynne Franks and explained that he was going to go with the self-deprecating jokes that he was using with some success on the after-dinner circuit, including the “total crap” line. Franks told him to give a speech about ethical business instead. He ignored her. He also ignored his wife’s advice and even that of the woman operating the autocue.
A textbook example of dismissing good advice? Unfortunately it’s not so clear-cut. Ratner asked his company accountant, a trusted associate, who told him to put in riskier jokes. Ratner recalls that his friend Michael Green, of Carlton Communications, thought the speech was fine. So did Charles Saatchi. (All the female critics were correct; all the men were wrong. It is not clear whether this is a pattern that we can rely upon. Perhaps.) In short, you can get good advice, but you still have to decide whose advice to take.
Failure isn’t going away. The economist Paul Ormerod points out (in a book called Why Most Things Fail, of course) that more than 10 per cent of American companies disappear each year. Failure is ubiquitous, which suggests that managing failure is an important skill. We are probably not very good at it. One of the earliest findings in the now red-hot field of behavioural economics was the existence of “loss aversion” – that is, we seem to care more about losing what we have than we care about gaining something new. More recent research into stock market trading, professional poker and even the daytime television sensation Deal or No Deal suggests that we react poorly to the prospect of losses, taking unwise risks in an attempt to recoup what we should regard as gone.
When Ernst Malmsten says he never recognised that failure was possible, this is not how most people think. The typical person – at least in the laboratory games of psychologists and economists – is too conservative, too afraid of failure. Malmsten, however, is a serial entrepreneur; after losing $130m of investors’ money, he says, “I’m more afraid of failure now”. He should be.
Lucy Prebble is perhaps in the strangest position of our three survivors: she wrote one play and received two very different critical and commercial responses on opposite sides of the Atlantic. No wonder she feels “distanced” from the play’s British success. It’s a reminder that success and failure are sometimes separated by the smallest accidents.
And yet they will always feel very different. As motivational posters remind us, Rudyard Kipling urged us to “meet with triumph and disaster and treat those two impostors just the same”. It’s an unlikely thought. Some people can flourish in the wake of disaster; others merely drag themselves on to whatever comes next. But to treat triumph and disaster just the same? That sounds suspiciously like Donald Rumsfeld.
………………………………………….
Lucy Prebble
Writer of Enron – a West End hit and Broadway flop
At 28, playwright Lucy Prebble became the darling of British theatre critics for doing the unthinkable – making a drama out of accountancy. Her musical, Enron, which charted the rise and fall of the Texan energy company, became a sell-out in London in 2009-2010. Broadway beckoned, and in April 2010 the show opened at the Broadhurst in New York.
Then came the reviews – or rather, one in particular. Ben Brantley, theatre critic of The New York Times, who wields huge influence over Broadway, decried Enron as a “flashy … laboured economics lesson”. In May 2010, a month after opening, the final curtain came down.
Prebble had her suspicions that the play might receive a poor critical reception in America: “It had followed a long preview period in which we had a sense that something was wrong.” There were some “very good reviews”, she points out, just not in “the publication that mattered”. However, it was the picture in her mind of her family reading the criticism that made Prebble cry. “Knowing the anxiety and disappointment that they would be feeling on my behalf … I found that very upsetting.”
The criticism hurt “both more and less” than she had expected: “Less,” she says, “in that it’s a group endeavour, and you feel much more the innate kindness and decency in people when they support each other in failure.” But it hurt more because she felt bad for the cast and crew, who became unexpectedly unemployed. Prebble felt guilty, and also responsible – for making people look foolish.
She accepted some of the criticism: “There were a few things mentioned about the writing that I had always quietly thought, but much of it I didn’t recognise as being the show we had made; some of it felt like it was about something else.” She regards criticism and failure as slightly different animals. “Failure is easier to discuss and more interesting, because obstacle is interesting. Failure serves as a very powerful tool, narratively.” But as she points out, the actor who happily recounts the tale of onstage disaster generally does so from a position of having left such times behind. “We all like it best when someone fails but eventually succeeds.” She finds criticism harder to discuss, “because it’s specific and personal, and the spirit in which it’s given varies so wildly. As writers, we are by nature too sensitive, too inward-looking. I try to take what I can learn from critics and leave the rest.”
Did Prebble’s failure in America change how she viewed her success in the UK? “I felt more grateful for it and also, sadly, more distanced from it.” But her New York experience did not affect the way she saw her play: “There are bits of my writing I cringed at and bits I was proud of. I always thought the production was fantastic.” Unexpectedly, it helped her identify with Jeffrey Skilling, the former chief executive of Enron, who is serving a 24-year jail term for fraud. “Underlying some of the criticism was a notion that: how could this British girl claim to know anything of international enterprise, of greed, business, of America, of this man who lost the people around him millions of dollars and saw all his work crumble in a few weeks? And the effect of that criticism [was that] I learnt the truth of the story I had been trying to tell.”
………………………………………….
Gerald Ratner
After-dinner speaker and former jeweller
Gerald Ratner transformed his family’s struggling business into the biggest jeweller in the world, with 2,500 shops. Then, seven years after he took over Ratners, he killed it. With just two jokes. In a speech he made in 1991 to the Institute of Directors, the north Londoner quipped that one of his products was “total crap”, and boasted that some of Ratner’s earrings were “cheaper than a prawn sandwich”.
The speech was splashed across the tabloids and wiped an estimated £500m from the company’s market value. Ratner left the following year and his name was excised from the company in 1994. Two decades after one of the biggest corporate gaffes in history, “Doing a Ratner” is firmly in the vernacular.
As Ratner gave his speech, he had no idea of the impact it would make. “When I read about it in The Sun and The Mirror the next day, I realised it was a story,” he says, “but [thought] it would blow over. The first set of sales I got after the speech were 4 per cent down, but I was pretty confident that would reverse.” If only. In fact, the opposite happened. When Ratner realised the extent of the mess he “felt sick to the stomach”.
Today, Ratner maintains that “it was a stupid thing for me to say, but the reaction was completely over the top”. Context is all, he says – blaming the furore on the recession Britain was suffering at the time. “The press were looking for scapegoats, just as they are with bankers now. And there I was – as they saw it, a multimillionaire making jokes about his customers who were struggling with money.”
Ratner’s spectacular fall from grace triggered what he calls his “seven wilderness years”. Friends offered help, but “I was depressed,” he says. He hoped to reinvent himself, but “the elephant in the room” put people off: no one could think of his successes, just this one gaffe. A psychiatrist prescribed antidepressants, “which took away the heavy feeling but made me more withdrawn. I didn’t speak – I was silent in meetings.” He gave up the pills for cycling, and it was this that proved his salvation – it left him “euphoric”. Today, he cycles 25 miles every day.
It was only after he set up a chain of health clubs, which he sold for £3.9m in 2001, that Ratner felt able to tackle his demons and even joke about the collapse of his family business. He insists he learnt nothing from failure. “The opposite. I learnt from success – while I was successful, I learnt from new opportunities and challenges, I gained confidence. With failure, you lose your confidence.”
Nonetheless, he is grateful for a few things – cycling, and a new career in after-dinner speaking. “The speeches are therapeutic. It’s better to talk about the episode. People are generally sympathetic. I think they worry I’m going to be miserable but I cheer people up – it chimes with others, as it makes them think there’s light at the end of the tunnel.”
The failure also taught him to appreciate his new business, the jeweller Gerald Online. “I’m more grateful for my success the second time around.” Before, his attitude to money was “pathetic”, he says. “If the seat was too far back in first class, it wasn’t good enough.” He is a more patient person now, yet that is scant compensation. “People ask me if I’m glad I said what I said. They’re ridiculous. How could I be grateful? I lost everything.”
………………………………………….
Ernst Malmsten
Co-founder of Boo.com
In 2000, Ernst Malmsten made a desperate plea for money. “Unless we raise $20m by midnight, Boo.com is dead.” The Swedish co-founder of the European online fashion retailer failed to find the funds. The next day, on May 18 2000, less than a year after its launch, Boo.com collapsed. The site, once a posterchild for the dotcom boom, became a symbol of its excesses, burning $130m of investment.
“We weren’t in denial that it was collapsing,” Malmsten recalls, “that’s why we were raising funds. But when it collapsed it was a shock, like a sudden death.” He felt hollow. “I never felt relief that it was over. I know some people feel liberated [when their company folds]. I didn’t. I felt emptiness. I loved the business and was so proud of it. We thought we were unstoppable.” He does concede that this may have been proof of the board’s naivety.
Nonetheless, there was solace to be drawn from the fact that Boo.com’s demise was part of a worldwide phenomenon, the bursting of the dotcom bubble – for this meant that the failure did not feel so personal. And the publicity that the company’s demise attracted was a boon, says Malmsten. “Because we were so high-profile it was easier.
Our failure was very public, so friends and family knew to rally round us. If it had been private failure and we were isolated, we might not have got that much personal support.”
Malmsten credits his robustness to his upbringing. “I never felt there was an expectation on me to succeed,” he says. “Knowing that my family would always support me helped – I knew that there was always a place to go to make me feel safe.” Malmsten believes that this security protected him from depression, and says that “I think I coped well.” After the shock, he says, he analysed what went wrong and then “moved on”. While he does not accept all the criticism flung at him at the time
(“We could never have lived up to the hype”), he acknowledges that he can’t minimise the failure.
“At the end of the day, we were trying to build an empire and it fell apart.”
Malmsten had feared his high-profile business collapse would make people steer clear of him. In fact, he says, “It doesn’t put people off. They think it is fascinating that I was a young person at the centre of a business phenomenon.” He also claims that he has not been short of job offers. Today, as chief executive of Lara Bohinc, the UK-based accessories designer, in which he has a 40 per cent stake, he says he is more cautious. “Boo.com made me more risk averse … We were young then and didn’t think of failure as a possibility. I’m more afraid of failure now, as I understand that businesses can fail, whereas before, I don’t think I did.” In fact, Malmsten admits to having been reluctant to venture into e-commerce again. “We have been slow to launch a website at Lara Bohinc. We could have done it earlier but I wanted to take time … we [did] a lot of beta testing.”
As a European, he says, he feels more comfortable discussing failure than success, because “in Britain and Scandinavia we’re more modest [than in America]”. People in European cultures, he says, are much more honest and analytical about failure than success. “Are you really going to [confess that your success] is due to screwing someone over?”

Interviews by Emma Jacobs

New York Times Magazine – 15 May 2011 – Graphic by CÉSAR A. HIDALGO and ALEX SIMOES

These diagrams are the early fruits of a new approach to the most important unsolved problem of the last century: how to make a rich country out of a poor one. Development economists have many theories about how the trick is done but few proven answers. A compelling solution would be useful closer to home, too: understanding the process of economic development would help us work out whether it matters that service jobs are replacing manufacturing ones or whether there is anything the government can and should do to stimulate new industries like biotechnology or green energy.
Strip away the mathematical language of economists, and conventional theories of economic growth are rather crude. Economies produce “stuff,” and if you want more stuff to come out of the process, put more stuff in (like human capital, say). Yet economies do not produce stuff so much as billions of distinct types of goods — perhaps 10 billion, according to Eric Beinhocker of the McKinsey Global Institute — ranging from size 34 dark stonewash bootcut jeans to beauty therapies involving avocado. The difference between China’s economy and that of the United States is not simply that China’s is smaller; it has a different structure entirely…

Continued on NYTimes.com

It’s “Adapt: The Movie.” Well, almost.

Click here to view the embedded video.

“Adapt” is being published in the US this week, so here’s a sneak preview of some of the ideas.

“This game is going to end up like the tortoise and the hare,” Michael Lewis declares, halfway through his inaugural game of Saint Petersburg. Lewis’s green wooden pawn is well ahead on the board, but he’s already picked up enough of the game to realise that – to paraphrase one of the characters he describes in his book The Big Short – he’s about to get his eyeballs ripped out.

It is hard to understand quite why Lewis has agreed that I will teach him an obscure modern German board game while he is interviewed. Poker would have seemed the obvious choice. Liar’s Poker, Lewis’s description of the surreal Wall Street world he inhabited for two years as a bond trader at Salomon Brothers, was definitive of an era and, to some extent, of Lewis’s own career as a narrative writer. But Lewis isn’t interested.

“I haven’t played poker since I was in high school,” he says. “It would be false to portray me as a gambler. It bores me. It’s always bored me.”

Was that why he left Salomon Brothers to become a writer? “No. It was fun gambling with other people’s money. I liked that.”

In a small meeting room in a Mayfair hotel, the logistics are awkward: I can’t take notes and it’s hard even to talk because we’re concentrating on the board. Even a simple game can be baffling to a first-timer, and Saint Petersburg is not a particularly simple game. It describes the building of the city by Peter the Great and his minions (but the theme is very loose: the artwork depicts Czarist Russia).

Players buy cards which provide a flow either of roubles – the currency to buy more cards – or of victory points, which advance the player’s pawn and bring victory closer. There are four types of cards: aristocrats, who supply money and victory points and a bonus at the end; buildings, which supply victory points; peasants, who supply money; and upgrades, which improve the other three types. Returns on investment are very high, but there are never enough roubles to buy all the bargains on offer.

I am about to offer some opening hints when Lewis cuts me off. “Don’t tell me tactics. You don’t have to tell me. I’ll screw up. I’d rather just get beaten, and learn that way.”

We play in fits and starts, for the first half hour talking only about the game and its rules, before switching to Lewis himself while the game is forgotten for a while.

I’ve been reading The Big Short, his account of the men who bet against the subprime bubble, and express my baffled admiration at his ability to get inside the heads of his characters. One, the hedge fund owner-manager Michael Burry, gave him access to every e-mail he had ever sent. “God’s gift to the narrative writer was Michael Burry’s e-mail trove. He lived his life via e-mail.”

But how does he persuade people to give him such access?

“I never really thought about it. I’ve had so many people enter into the spirit of the arrangement. It starts with the relationship before it becomes a literary engagement. It’s a very long-term investment.”

The only time he’s had someone pull out after beginning such a relationship was with George Soros, whom he had accompanied on a private plane all over eastern Europe in 1994. Lewis published a magazine piece which suggested that Soros’s qualities as a philosopher were overrated.

“He was furious with the piece. It just said what I thought. Is it my turn?”

“Your turn.”

Lewis is fascinated at the revelation that Germany is the world’s board-game heartland. “This game is all about trade-offs … it’s made for the Anglo-Saxon Protestant work ethic. The Greeks would never appreciate it.” He tries to persuade me to write a piece about the German response to the euro crisis, using board games as a motif.

Although I am building a winning position, producing a flow of roubles that will in due course allow me to buy what I need to overtake Lewis, he understands what is going on. He knows why he’s going to lose. After I reap a particularly profitable investment, Lewis expresses alarm.

“Sorry,” I offer.

“That’s OK.”

Talk turns to Lewis’s upbringing in New Orleans. His father had a largely hands-off philosophy, but begged Lewis not to turn down Princeton in favour of a life in New Orleans with his high-school sweetheart. “He went white and said, ‘I’ve never told you what to do, but don’t do this.’”

Lewis followed his father’s advice. “It was the right decision. But I really was in love with that girl, and it ended up ending our relationship. And I always felt I violated something in me, making that decision.” When the time came to quit Salomon, he steeled himself against any further paternal entreaties.

. . .

Explaining his decision to leave Salomon, he casually compares the $40,000 book contract to the $250,000 salary and potentially millions more – big sums in the late 1980s. But he insists that money does not motivate him.

“I grew up with a mother who came from a pretty wealthy family – in fact a very wealthy family by New Orleans standards – and my father was kind of a poor boy.” By the age of nine he’d abandoned any sense that money brought fulfilment, because “my father’s family was so happy and my mother’s family so miserable”.

Although there is outrage in Lewis’s descriptions of high finance, it is muted by the fact that he seems to regard much of life on Wall Street as risible. His former tutor at the London School of Economics, a certain Mervyn King, didn’t always see the funny side.

“Four or five months after I got the job at Salomon, the head of the London office comes over to me and says, ‘We’ve got this guy in the lobby. He’s the academic adviser to the new FSA, and he’s been sent in to see how the markets really work and nobody wants to sit with him. Could you sit with him?’ It was Mervyn.”

After three hours “listening to me selling people stuff”, King asked what Lewis was paid.

“It was two-and-a-half times what they were paying him to teach me at LSE. And he was, ‘This is just criminal, this is outrageous.’ He couldn’t believe it.”

I realise that Lewis has been hoping to overtake me, banker-style, by scooping a big bonus score at the last gasp, but he has missed a subtlety of the scoring and gets less than he hoped. He is, in any case, too far behind for any bonus to help him. The final score – 197 to 147 – is a comfortable win for me, but no disgrace to my pupil. We’ve been playing and talking for two hours.

“How do you feel?” he asks me.

“Pretty scummy, actually.”

“No that’s alright, that’s alright. I learned.”

…………………………………………..

Also published at ft.com.

Hinkley Point B is an ageing power plant overlooking the Bristol Channel. The location was once designed to welcome visiting schoolchildren, but is now defended against terrorists by a maze of checkpoints and perimeter fencing. At the heart of the site, which I visited on a mizzling, unseasonable day in late July, looms a vast grey slab of a building containing a pair of nuclear reactors.

Hinkley Point B began operating shortly before the doomed TMI-2 reactor at Three Mile Island in Pennsylvania, US, and is due to be decommissioned after 40 years of service in 2016. As parts of the plant are showing the industrial equivalent of crow’s feet, it runs at 70 per cent capacity to minimise further wear and tear. But when I asked EDF Energy, a subsidiary of one of the world’s largest nuclear energy companies, whether I could visit a nuclear facility to talk about safety, Hinkley Point B was the site they volunteered.

It might have seemed a strange choice on their part, but I was on a strange mission. I hadn’t come to Hinkley Point B to learn about the safety of nuclear energy. I’d come because I wanted to learn about the safety of the financial system.

The connection between banks and nuclear reactors is not obvious to most bankers, nor banking regulators. But to the men and women who study industrial accidents such as Three Mile Island, Deepwater Horizon, Bhopal or the Challenger shuttle – engineers, psychologists and even sociologists – the connection is obvious. James Reason, a psychologist who studies human error in aviation, medicine, shipping and industry, uses the downfall of Barings Bank as a favourite case study. “I used to speak to bankers about risk and accidents and they thought I was talking about people banging their shins,” he told me. “Then they discovered what a risk is. It came with the name of Nick Leeson.”

Peter Higginson, the head of safety at Hinkley Point B, also thinks there is a parallel. An earnest physicist in a dark-blue shirt and tan slacks, he breaks off from a long safety briefing to muse about banking. “I have done my own thinking about the financial crisis,” he says. “Could they have learned something from us? I ask the question.”

One catastrophe expert who has no doubt about the answer is Charles Perrow, emeritus professor of sociology at Yale. He is convinced that bankers and banking regulators could and should have been paying attention to ideas in safety engineering and safety psychology. Perrow published a book, Normal Accidents, after Three Mile Island and before Chernobyl, which explored the dynamics of disasters and argued that in a certain kind of system, accidents were inevitable – or “normal”.

For Perrow, the dangerous combination is a system that is both complex and “tightly coupled”. Harvard university is a complex system. A change in US student visa policy; or a new government scheme to fund research; or the appearance of a fashionable book in economics, or physics, or anthropology; or an internecine academic row – all could have unpredictable consequences for Harvard and trigger a range of unexpected responses.

A domino-toppling display is not especially complex, but it is tightly coupled. So is a loaf of bread rising in the oven. For Perrow, the defining characteristic of a tightly coupled process is that once it starts, it’s difficult or impossible to stop.

Nuclear power stations are both complex and tightly coupled systems. They contain a bewildering array of mechanisms designed to start a nuclear reaction, slow it down, use it to generate heat, use the heat to generate electricity, intervene if there is a problem, or warn operators of odd conditions inside the plant. At Three Mile Island, the most famous nuclear accident in US history, four or five safety systems malfunctioned within the first 13 seconds. Dozens of separate alarms were sounding in the control room. The fundamental story of the accident was that the operators were trying to stabilise a nuclear reactor whose behaviour was, at the time, utterly mysterious. That is the nature of accidents in a complex and tightly coupled system.

Perrow believes that finance is a perfect example of a complex, tightly coupled system. In fact, he says, its complexity “exceeds the complexity of any nuclear plant I ever studied”.

So if the bankers and their regulators did start paying attention to the unglamorous insights of industrial safety experts, what might they learn?

. . .

It might seem obvious that the way to make a complex system safer is to install some safety measures. Engineers have long known that life is not so simple. In 1638, Galileo described an early example of unintended consequences in engineering. Masons would store stone columns horizontally, lifted off the soil by two piles of stone. The columns often cracked in the middle under their own weight. The “solution” – a third pile of stone in the centre – didn’t help. The two end supports would often settle a little, and the column, balanced like a see-saw on the central pile, would then snap as the ends sagged.

Galileo had found a simple example of a profound point: a new safety measure or reinforcement often introduces unexpected ways for things to go wrong. This was true at Three Mile Island. It was also true during the horrific accident on the Piper Alpha oil and gas platform in 1988, which was aggravated by a safety device designed to prevent vast seawater pumps from starting automatically and killing the rig’s divers. The death toll was 167.

In 1966, at the Fermi nuclear reactor near Detroit, a partial meltdown put the lives of 65,000 people at risk. Several weeks after the plant was shut down, the reactor vessel had cooled enough to identify the culprit: a zirconium filter the size of a crushed beer can, which had been dislodged by a surge of coolant in the reactor core and then blocked the circulation of the coolant. The filter had been installed at the last moment for safety reasons, at the express request of the Nuclear Regulatory Commission.

The problem in all of these cases is that the safety system introduced what an engineer would call a new “failure mode” – in other words, a new way for things to go wrong. And that was precisely the problem in the financial crisis.

The notorious repackaged mortgages – in the form of residential mortgage-backed securities (RMBS) and collateralised debt obligations (CDOs) – were financial safety systems that offered exciting new ways to blow things up. The safety mechanism was a complex legal structure to alter the distribution of the risks from mortgage defaults. In principle, this made the risks more comprehensible and the right sort of investor could take on the right degree of risk. In practice, the repackaged mortgages – especially when the repackaging was repeated several times – made the behaviour of the risks as incomprehensible as a malfunctioning nuclear reactor.

For instance, investors had to take a view on how likely mortgage defaults were, and the extent to which – like London buses – they all arrived at the same time. (Clearly, there was some degree of clustering: the challenge was to estimate it without much data.) Few people realised that the same CDO safety system, which appeared to parcel risks in a predictable way, also made investors vulnerable to errors in their assumptions. A one-in-a-million chance of taking a loss could become a million-to-one chance against getting any money back at all.

Part of the problem was what risk experts call “risk compensation”. Just as safety belts appear to encourage drivers to feel safe and take more risks, the apparent safety of CDOs encouraged banks to bet their entire franchise on them. (In both cases, bystanders often become casualties.) But the subtler effect was that of these new failure modes.

A second spectacular example is another financial safety system, the credit default swap. Credit default swaps were explicitly designed as a safety measure, a form of insurance against a company, including a subprime CDO, failing to pay its debts. Many major banks turned to the insurance giant AIG, or to “monoline” insurers, which sold credit default swaps to insure the banks’ investments. When the investments went bad, AIG and the monolines couldn’t pay – and the safety measure suddenly became a source of systemic risk. Bonds are given a credit rating by rating agencies, but if the bonds are insured they inherit the credit rating of their insurer. When AIG’s credit rating was downgraded, so were the ratings of the bonds it was insuring – which meant some banks were forced to sell them to meet their regulatory obligations. Financial institutions didn’t have to have any involvement at all with subprime products: if they were holding bonds that AIG or the monolines had insured, they could be sucked into the crisis by the unexpected interaction of a safety regulation and an insurance-based safety mechanism.

A series of measures intended to guarantee the safety of individual financial institutions had brought the system to its knees. To industrial safety experts, such unintended consequences are commonplace. So if a Rube Goldbergesque accretion of one safety system after another is not the solution to industrial or financial catastrophes, what is?

. . .

The 1979 crisis at Three Mile Island remains the closest the American nuclear industry has come to a major disaster. It would have been far less grave had the operators understood what was happening. Coolant pumps were useless because a maintenance error had trapped them behind closed valves. Another valve jammed in the open position, allowing pressurised radioactive water at more than 1,000° C to shoot into the sump below the reactor, eventually exposing the reactor core itself and risking a complete and catastrophic meltdown.

The operators were baffled by the confusing instrumentation in the control room. One vital warning light was obscured by a paper repair tag hanging from a nearby switch. The control panel seemed to show the jammed-open valve had closed as normal – in fact, it merely indicated that the valve had been “told” to close, not that it had responded. Later, the supervisor asked an engineer to check a temperature reading that would have revealed the truth about the jammed valve, but the engineer looked at the wrong gauge and mistakenly announced that all was well.

All these errors were understandable given the context. More than 100 alarms were filling the control room with an unholy noise. The control panels were baffling: they displayed almost 750 lights, each with letter codes, some near the relevant flip switch and some far. Red lights indicated open valves or active equipment; green indicated closed valves or inactive equipment. But since some of the lights were typically green and others were normally red, it was impossible even for highly trained operators to scan the winking mass of lights and immediately spot trouble.

I asked Philippe Jamet, the head of nuclear installation safety at the International Atomic Energy Agency, what Three Mile Island taught us. “When you look at the way the accident happened, the people who were operating the plant, they were absolutely, completely lost,” he replied.

Jamet says that since Three Mile Island, much attention has been lavished on the problem of telling the operators what they need to know in a format they can understand. The aim is to ensure that never again will operators have to try to control a misfiring reactor core against the sound of a hundred alarms and in the face of a thousand tiny winking indicator lights.
Steve Mitchelhill and traders in Brazil

At Hinkley Point B, next to the main plant, is a low-rise office building of an inoffensive style that has adorned countless nondescript business parks. At the heart of that building is the simulator: a near-perfect replica of Hinkley Point B’s control room. The simulator has a 1970s feel, with large sturdy metal consoles and chunky Bakelite switches. Modern flat-screen monitors have been added, just as in the real control room, to provide additional computer-moderated information about the reactor. Behind the scenes, a powerful computer simulates the nuclear reactor and can be programmed to behave in any number of inconvenient ways.

“There have been vast improvements over the years,” explained Steve Mitchelhill, the simulator instructor who showed me around. “Some of it looks cosmetic, but it isn’t. It’s about reducing human factors.”

“Human factors”, of course, means mistakes by the plant’s operator. And Mitchelhill goes out of his way to indicate a deceptively simple innovation introduced in the mid-1990s: coloured overlays designed to help operators understand, in a moment of panic or of inattention, which switches and indicators are related to each other.

The lesson for financial regulators might seem obscure. But at key points during the crisis, they were as “lost” as the operators of Three Mile Island. For example, as Lehman Brothers teetered on the brink of insolvency, all eyes were on the doomed bank. Tim Geithner, the man responsible for supervising Wall Street’s banks, had a meeting at the request of Robert Willumstad, the chief executive of AIG. As an insurance company, AIG was regulated by the US Treasury and by state regulators, so it was far from obvious why Willumstad was Geithner’s problem. Geithner was exhausted after an overnight flight and distracted by what appeared to be the overwhelmingly important question: what to do about Lehman Brothers. According to journalist Andrew Ross Sorkin, Geithner kept Willumstad waiting because he was on the phone to Dick Fuld of Lehman Brothers, and fidgeted throughout the meeting because he didn’t really understand why Willumstad wanted to see him. Willumstad, eager to get some support from the Federal Reserve but anxious not to panic Geithner, handed him a briefing note summarising how exposed banks were to a potential failure at AIG. When he left, Geithner filed the note with barely a glance and went back to the problem of Lehman Brothers. Five days later the government realised that AIG was about to wreck the financial system and gave it a vast injection of capital.

“We always blame the operator – ‘pilot error’”, says Charles Perrow, the Yale sociologist. But like a power plant operator staring at the wrong winking light, Geithner had the wrong focus not because he was a fool, but because he was being supplied with information that was confusing and inadequate.

Some economists and regulators have, belatedly, started to focus on this issue of information design. The Dodd-Frank reform act, signed by President Obama in July, establishes a new Office for Financial Research that seems likely to try to draw up a “heat map” of stresses in the financial system. Andrew Haldane, director for financial stability at the Bank of England, looks forward to the day when regulators will have such a map. He argues that the same technologies now used to check the health of an electricity grid could be applied to a financial network map, highlighting critical connections, overstressed nodes and unexpected interactions. “We’re a million miles away from that at the moment,” he readily admits.

Such a real-time map would certainly help make sense of the new “Basel III” capital requirements for banks. These measures, agreed last September, made provision for additional “loss-absorbing capacity” for “systemically important banks”. Well and good, but right now the definition of a systemically important bank is much the same as the definition of pornography: we know it when we see it. That is unlikely to be much help.

. . .

Perhaps the most profound and worrying parallel between preventing industrial catastrophes and financial ones emerges from Perrow’s pessimistic theory of “normal accidents”. For him, any sufficiently complex, tightly coupled system will fail sooner or later. The answers are to simplify the system, decouple it, or reduce the consequences of failure.

What might decoupling the banking system mean? Consider the slightly obsessive pastime of domino-toppling. One of the first domino-toppling record attempts – 8,000 stones – came to a premature and farcical end because a pen dropped out of the pocket of the television cameraman who had come to film the occasion. Other record attempts have been disrupted by moths and grasshoppers. It’s the quintessential tightly coupled system.

Professional domino-topplers now use safety gates, removed at the last moment, to ensure that when accidents happen they are contained. In 2005, a hundred volunteers had spent two months setting up 4,155,476 stones in a Dutch exhibition hall when a sparrow flew in and knocked one over. Because of safety gates, only 23,000 dominoes fell. It could have been much worse. (Though not for the hapless sparrow, which an enraged domino enthusiast shot with an air rifle.)

Given the propensity of finance to suffer frequent meltdowns, Perrow’s normal accident theory almost certainly describes the banking system. The financial system will never eliminate its sparrows (perhaps black swans would be a more appropriate bird) so it needs the equivalent of those safety gates. Rather than making a particular bank less likely to fail, it might be safer to focus on ensuring that one falling bank doesn’t topple other companies.

But few financial commentators have considered the implications of that. One notable exception is John Kay, a British economist and FT columnist, who argues for a system of “narrow banking” which, he asserts, would lead to “a far more robust industry structure, with simpler institutions, less interconnectedness, and greater diversity of industry structure”. Another is Laurence Kotlikoff, an economist at Boston university, who has a proposal for “limited purpose banking”. Both Kay and Kotlikoff have taken the view that it is worth pursuing a simpler and less tightly coupled financial system for its own sake – in sharp contrast to the prevailing regulatory approach, which unwittingly encouraged banks to become larger and more complicated, and actively encouraged off-balance sheet financial engineering. I do not know whether Kay or Kotlikoff have the right answer. Normal accident theory suggests that they are certainly asking the right question.

Also published at ft.com.

‘The welfare of a nation can … scarcely be inferred from a measure of national income.’
So the US Congress was warned in 1934 by Simon Kuznets, who thus continued a long tradition of pointing out that there is more to life than money. But the economist’s comments broke particular ground: they were attached to the first serious attempts to produce national income accounts – the tally of all that a country produces and earns – for the US. Kuznets and his small research team had built them, and he knew their limits.
Where Kuznets led, others have followed. From the upper echelons of the administration of President Barack Obama to the offices of Nicolas Sarkozy, his French counterpart, to David Cameron, UK prime minister, the goal of gauging a nation’s well­being has captured the imagination of policymakers. They join less likely countries such as Bhutan, whose mission to measure “gross national happiness” has made the Himalayan mountain kingdom a trendsetter.
Mr Cameron was the most recent to take up the cause, saying Britain needed to look for alternative measures that would show national progress “not just by how our economy is growing, but by how our lives are improving; not just by our standard of living, but by our quality of life”. While some analysts suspect each politician has his own motives – appearing nice to electors, flattering the economy and so on – the result has been to create a sense of momentum behind happiness economics.
Embracing happiness is one thing; measuring it another. There are, broadly speaking, three approaches to measuring a country’s wellbeing. One is to use the long-established framework of national income accounts and adjust it to better reflect national welfare. The second is to collect data on objective measures that are plausibly related to wellbeing: anything from life expectancy to crime, suicide rates to income inequality. The third – and the three are not mutually exclusive – is to try to measure national welfare directly by asking people how they feel: the equivalent of measuring wealth by asking: “On a scale of one to 10, how rich are you?”
Intellectually the project of measuring national welfare seems to belong on the centre-left. National income accounts themselves – like unemployment statistics – rose to prominence in the 930s as Franklin Roosevelt tried to lead the US out of the Great Depression and the government recognised it understood very little about how the economy was really doing – beyond very badly. The second world war and the central planning mentality that came with it merely intensified the focus on the government being able to understand how the economy was functioning.
The countervailing view was most pithily expressed by John Cowperthwaite, the laisser-faire financial secretary of Hong Kong in the 1960s, who claimed he refused to collect economic statistics because it would only provide ammunition to the planners. His views have not prevailed. Kuznets won the Nobel Prize in economics in 1971 – only the third year in which it was awarded – and it is hard to find serious economists who think that collecting national income accounts is pointless. The question is whether there is a benefit in trying to supplement those with accounts of national welfare – or, to put it cutely, an index of national happiness.
Mr Cameron says that there is. “You cannot capture happiness on a spreadsheet any more than you can bottle it,” he declared last month. The happiness index project, he added, had a practical purpose: to help the government understand, “with evidence”, the best way of improving people’s wellbeing. In short, Mr Cameron believes happiness indices can help his Conservative-Liberal Democrat coalition government plan its way to a happier nation in the same way Kuznets’ national accounts helped policymakers respond to the Depression and the outbreak of war.

…

Before understanding what governments might do with measures of happiness, it is worth asking how to measure it. Although “neuro-economists” are not averse to sticking people into brain scanners with a view to gleaning their inner thoughts, the easiest way to find out whether somebody is happy is to ask them. This might seem uncontroversial; after all, it seems almost definitional that if you’re happy then you know it.
Yet even here there are two quite distinct approaches. The first, and best known, is to collect information about “life satisfaction”, asking people how satisfied they are with their lives, taken as a whole, on (for instance) a scale of one to 10, eliciting a once-and-for-all answer to the question of how life is working out.
The alternative is to zoom in on a particular set of events and ask what feelings they produced. One example is the “day reconstruction method” produced by researchers including Norbert Schwarz, a psychologist, the economist Alan Krueger (until recently chief economist of the US Treasury), and Daniel Kahneman, a psychologist and another winner of the Nobel memorial prize in economics. The DRM asks people to recall, episode by episode, the previous day’s events and the most prevalent accompanying feeling – stress, peace, exhaustion, elation.
In short, one approach measures life satisfaction and the other mood – and the two concepts are quite different ways to think about happiness. One survey comparing women in Rennes, France, and Columbus, Ohio, found that the American women were twice as likely to say they were very satisfied with their lives, but the Frenchwomen spent more of their day in a good mood. “We have tended for too long to use a single word to refer to a wide variety of things,” says Prof Kahneman. “In particular there’s a real need to distinguish between life satisfaction and mood or experienced happiness. They are quite distinct and they have different causes and consequences.” If politicians are to incorporate the measurement of happiness into the fabric of national statistical frameworks, this is a distinction they will have to start taking seriously.
One obvious objection to the new-found emphasis on indicators of national welfare is that it is not, in fact, new-found at all. The most famous (albeit contested) finding in happiness economics is the Easterlin Paradox – that money buys happiness in any given society but richer societies seem to be no happier than middle-income ones – which dates back to the 1970s.
Still, data on subjective wellbeing have been improving ever since. The UK has published Social Trends for four decades, an almanac for modern times that includes information on crime and the fear of it, attitudes to marriage, satisfaction with the National Health Service, calls to child protection numbers, air pollution, North Sea fish stocks and much else. Other countries do likewise.

…

This puts the wellbeing agenda in a strange place. Those who believe in it know that the data already exist: Andrew Oswald of Warwick University and a leading advocate of the use of well­being data points to the UK’s Labour Force Survey, which already includes questions on depression and anxiety. Prof Oswald wants to see more such questions and have more attention paid to them, but this is a request to do more rather than to do something profoundly different.
But professors Kahneman and Krueger, and others, do have plans for a more radical departure. They propose the publication of “time accounting” measures alongside regular national accounts. The US Bureau of Labour Statistics has, funded by the National Institute on Aging, begun to implement some of their proposals.
Time-use surveys use representative samples to see how a nation spends its time – whether cooking, commuting or watching television. They are a well-established part of the US statistical apparatus. The happiness element comes in when the surveys are combined with the DRM. Because this asks survey respondents to rank the emotions they felt while spending time in various activities, it can be used to produce a measure of how long people spend in a predominantly unpleasant state of mind – as well as the kinds of things they are doing at the time. (For the curious, the particularly miserable activities include commuting and working. Sex, lunch and dinner are rarely unpleasant.)
The Kahneman-Krueger team have developed a stripped-down version of the DRM, which can be conducted as a regular telephone survey, and the Bureau of Labour Statistics has already conducted its first survey with the new method. Pilot studies seem to produce results broadly faithful to the DRM; the first data from the BLS work are due early in 2011.
Will national time accounts – or some alternative measure of welfare – give politicians a tool of practical importance? Or will Cowperthwaite be proved correct: that the data will only encourage politicians to meddle? Prof Krueger thinks not. “This approach is particularly amenable to evaluating public policy interventions, as investing in roads and high-speed rail can affect commuting time, overtime laws affect work hours, and playgrounds affect leisure activities.”
National time accounts will do more than that, because they sidestep an insuperable problem of the life satisfaction approach: that one person’s five out of 10 might be another person’s eight out of 10. Up to a point this problem can be shrugged off, especially when looking at large sample sizes, but if there are systematic differences between the way people express these judgments – differences between urban and rural, white and black, men and women, Danish and French – the data cannot be used to make comparisons across these groups. (In one Eurobarometer survey, 64 per cent of Danes described themselves as “very satisfied” and only 16 per cent of French. It is tempting to question how much the survey really tells us about the relative wellbeing of France and Denmark.)
National time accounts measure how much time people spend engaged in activities where the strongest of many emotions is a negative one. This greatly lessens the interpersonal comparability problem (although it cannot remove it entirely). In the end it may produce controversial findings – imagine, for instance, if it were shown that women spent far more time doing things they disliked than men did, or that the elderly lived blessed lives compared with the young.
The UK Office for National Statistics will continue its consultation until mid-April. By then the first American time-use accounts should be available. If Mr Cameron is serious about happiness, he will be casting an optimistic glance across the Atlantic.

FT Analysis 28 December 2010
Full version (graphs, sidebar) available at FT.com

Illustration by Ingram Pinn

Anniversaries are a time for reflection and, as the third anniversary of the credit crunch approaches, I have been doing some reflecting on where I went wrong as an economist. My own errors, of course, are of particular interest only to me, but I fear that they are fairly representative of the economics profession.

To soften the blow, I have also been thinking about where I didn’t go wrong. I still believe that government interventions tend to be clumsy; I still believe that markets usually provide good solutions to economic problems; and I still believe that people tend to respond rationally to incentives. I may be wrong about all of these things, but not because the banking crisis has demonstrated that they are false.
The near-collapse of the banking system demonstrated that governments are indispensable – but indispensable klutzes nonetheless. The various interventions were botched, unduly expensive, late and ill-suited to preventing a future crisis. But this is not surprising: all government interventions are designed by people with limited knowledge of conditions on the ground, tend to be one-size-fits-all, and are inevitably compromises between the public good, the knee-jerk bias of an ill-informed electorate and some formidable lobbyists. I am still profoundly grateful that governments did something rather than nothing.
As for the effectiveness of markets, this has surely not been called into serious doubt. The British government used to own British Airways, much of British Petroleum, British Telecom, the electricity industry, the gas industry and Rolls-Royce. Nothing in this crisis suggests that these companies must all be renationalised as soon as possible. But as the greenest student of economics will tell you, there are counter-examples to the principle that markets work and the financial system of the past five years has made a compelling case to be added to the list.
The belief in rationality may seem the most quixotic of all, but many elements of the crisis were provoked not by irrational behaviour but by rational responses to perverse incentives. Too many people were able to take the following bet: “Heads I win, tails the financial system loses.”
The countervailing view comes from behavioural economics, the intersection between economics and psychology. Like the young man who at the age of 14 thought his father was an idiot, and was then astonished at how much the old fellow had learnt in just a few years, I take behavioural economics much more seriously now than I used to. But this is not because the crisis has provided any great vindication of the discipline. Recent popularisations of behavioural economics, published as the crisis was beginning, talk about the psychological quirks that make people susceptible to predatory lending, but not about excessive leverage or hazardous financial instruments such as CDOs of CDOs.

True, the crisis has provided yet another feather in the cap of the behavioural economist Robert Shiller. Prof Shiller correctly identified the dotcom bubble in the late 1990s and then spotted the housing bubble a few years later. This is impressive and many economists took him seriously on both occasions. But the real puzzle here was not the existence of these two bubbles but the fact that the first burst with minor consequences while the second provoked a financial bloodbath.
The crisis provided just as much vindication for Raghuram Rajan, an eminent but perfectly orthodox Chicago-school economist, who in 2005 pointed to elevated house prices and to perverse incentives for investment fund managers, and warned that risk-management tools might be leading to an increased risk of catastrophe. There was no clever psychology here: Prof Rajan simply looked closely at what the basic incentives were and where they might lead.
Similarly, my colleague Gillian Tett made headway because she asked simple but probing questions: Where had all these derivatives come from? What were they supposed to be achieving? How exactly did they work? Spotting the warning signs required not some profoundly different worldview about the likelihood of rational behaviour or the merits of the market, but a curiosity about the details of what was going on under the hood of the financial system.
Which is what I got so wrong: I thought that the details did not much matter. Derivatives sounded like a sensible idea in principle and that was all I needed to know. I said very few silly things about banks only because I said very few things about banks, full stop. I wasn’t paying enough attention.
This is a failing that comes naturally to economists. One of the first and best popular economics books, The Armchair Economist, is as advertised: a collection of incisive essays about the world as an economist would think about it from his armchair. We economists like to ponder questions such as “why does popcorn cost so much at the movies?” and there is plenty we can say on the subject that is both true and counterintuitive. But the armchair does preclude one obvious research angle, which is to ask the people who run the cinemas.
The irony is that critics of economics often make the same mistake. I recently debated with the psychologist and social commentator Oliver James, who announced that the commendable qualities of the Scandinavian psyche had insulated them from the banking crisis. Well, that is one possible explanation: another possibility is that the Swedes have already had a severe banking crisis, commendable psyche notwithstanding, and remember what one looks like. (In other news, your office mate isn’t sipping water because of his ascetic character but because he has a hangover.)

But perhaps that is unfair. It is not the job of a clinical psychologist to study the history of banking crises, but it should be the job of an economist. It is all very well to believe that people respond to incentives, but we economists also need to ask what the incentives are.
So I shall be trying to take my own advice. I sometimes joke that although I didn’t know anything about banking when the credit crunch began, at least the people running the banks didn’t know anything about banking either. The joke always gets a laugh. I wonder if it is really that funny.

First published at FT Comment on 4 August 2010

Illustration by Ingram Pinn

It says a lot about the talents of John Maynard Keynes – and just as much about the shortcomings of modern macroeconomics – that when the financial crisis struck, policymakers instinctively reached not for their fancy models, but for the Keynesian idea of fiscal stimulus. These pages have been filled with eminent thinkers arguing over whether it is time to bring the stimulus to an end.

Perhaps we should turn the question around: if stimulus were to be the solution, what would be the problem? The problem would be that too many of us wanted to save money or pay off debts; that is, we wanted others to pay for our services but weren’t so keen on paying for theirs right now. Simple arithmetic suggests this would leave slack in the economy. In addition, the problem would be that businesses, pessimistic about prospects for recovery, didn’t harness all the spare savings floating around and plough them into new investment projects. The slack would stay slack, possibly for a long time. If that was the problem then government stimulus would be the solution.

And the above paragraph doesn’t seem to be a bad description of the US or UK economy, which suggests the case for stimulus is strong. True, the patience of the bond markets is surely not boundless (and say what you like about kowtowing to the markets, if we’d like them to lend us money we have good reason to care whether they are willing to lend it). And there already is an awful lot of stimulus spending going on right now, so it’s not absurd to suggest we could get by with less as the economy bounces back. I realise that I am sitting on the fence here, but it’s part of my new maxim, which is never to stand in the middle of a fight between Paul Krugman and Niall Ferguson.
Fiscal multipliers are certainly fun. If the fiscal multiplier is 0.5, we’re getting government projects at half price: the government project draws half its resources away from private-sector activity, but the other half is just soaking up slack. If the fiscal multiplier is 1.6, as President Barack Obama’s Council of Economic Advisers has estimated, we get a free government project and a larger private sector. And if the multiplier is 2.5, as Keynes believed of the US economy in the 1930s, government spending soaks up slack like a sponge, and also catalyses the private sector into a frenzy of action. (I beg your indulgence while you picture a slack-soaking catalytic sponge; patent pending.)
The quality of government spending still matters. If you think the multiplier is 2.5 then you can gladly follow Keynes’s suggestion of burying banknotes down mineshafts and leaving it “to private enterprise on well-tried principles of laisser faire to dig the notes up again”. If you think it is 0.5 or zero, you might want government projects chosen with more care. And as Keynes himself remarked, no matter what the multiplier, “it would, indeed, be more sensible to build houses and the like” if only politics would allow.
Keynes’s General Theory may well be a work of genius, but I have always been more attracted to his short 1930 essay, Economic Possibilities for Our Grandchildren, in which, in the teeth of the Great Depression, Keynes reminded us that the long-run trend was inexorable growth. “I would predict that the standard of life in progressive countries one hundred years hence will be between four and eight times as high as it is to-day,” he wrote. After 80 years, a world war, and a depression, citizens in the US and western Europe are about five times richer than when Keynes was writing. We seem to be on track.
Keynes’s essay explored something his modern disciples often ignore, namely what would happen when “the economic problem” was solved. By the standards of the 1930s, this problem has been solved. But our response has not been what Keynes expected. He acknowledged that human beings had an insatiable desire to feel superior to each other, and that some people would always blindly pursue wealth. But he felt that most of us would adjust, albeit grudgingly, to a life of plenty. We would work less and amuse ourselves in other ways. We have not, and civilisation continues to depend on the production, purchase, consumption and disposal of the kind of stuff you can see anywhere from the shelves of Walmart to the pages of How To Spend It. One of the multiple causes of the crisis, after all, was that so many people wanted to borrow more than they could repay.
It is true that we do choose to work a little less. According to the economists Mark Aguiar and Erik Hurst, despite a large increase in women’s participation in the workforce, in the US they have at least four hours a week of extra leisure compared with 1965. Men have at least six extra hours. And there is the time we spend studying and travelling before our careers, or in early retirement, to say nothing of the many hours spent goofing off at work and looking at Facebook. But if you want to work a three-day week, your boss and colleagues will assume it is because you are caring for a baby or studying for a PhD, rather than because the weather is lovely at this time of year.
So while the debate of the day is rightly about how quickly and how severely governments should tighten their belts, I hope that when the crisis is over we will remember to come back to Keynes’s long-run forecast. Keynesianism may be about trying to maintain full employment, but Keynes understood that full employment could mean everybody who wanted a job working up to three hours a day, at which frenetic pace we should still have twice the wealth of Keynes’s generation. It was in this future paradise that Keynes famously imagined that the economics profession might be thought of as “humble, competent people, on a level with dentists”. We economists have a way to go yet.

First published at ft.com

In a sprawling convention centre in Essen, western Germany, the busiest day in the German board games calendar – Saturday at “Spiel” – is about to begin. Hall after hall of stands are piled high with board game boxes, most eschewing the garish graphics of the toy shop for evocative paintings of lands far off and times long ago.
A few minutes before the official start time of 10am, the doors are thrown open. There’s a rumble and then a roar as thousands of gamers surge into the hall, breaking and swirling around the stands, sweeping into the farthest corners of the halls, seeking out rare second-hand products or the hottest of the 500 new games being launched, or simply a good place to sit and play. The biggest stands resemble pavement cafés whose patrons grab games instead of coffee: they are filled with tables, each just big enough to seat four players and a board. Before long, the spaces in between the tables are colonised, too, with gamers sitting cross-legged around their boards.
Beyond the sheer number of enthusiasts, the striking thing is that they look, well, normal. The convention centre boasts nearly as many mothers with prams as heavy-metal-T-shirted, body-pierced teens. In one of the farthest halls, Dungeons and Dragons merchandise is on sale, and I counted more than one person wearing a sword and a cloak. But for the most part, the convention centre’s population wouldn’t look out of place on any German high street.
“If you go to a games convention in the UK, you’re generally surrounded by fat, smelly people with bad social skills,” says Martin Wallace, a British game designer at a boutique games publisher called Warfrog. “That’s not true here.”
Wallace recalls an occasion when a group of his gaming friends were too embarrassed to admit their identities to a pretty waitress back home in the UK. “One of us told her that we were stamp collectors. I thought: great. We’re lower than stamp collectors.” But in Germany, if the leading game designers travel incognito, it is to avoid being surrounded by admiring fans.
A queue of autograph hunters forms at the Kosmos company’s stand: Klaus Teuber has arrived. Teuber, once a manufacturer of dental supplies, is an unlikely star. He is an avuncular man in his fifties with a hairless pate and a perfect trapezoidal moustache that fans out to the corners of his mouth. But for four days in Essen, he is the biggest name of all: the designer of the multimillion-selling blockbuster board game, The Settlers of Catan.

…

In 1996, when I was living in Oxford and studying economics, I tagged along one night to the home of a friend of a friend, where I was invited to play something called “Settlers”. Not the most daring of evening activities, but I shrugged and agreed. I’d played chess as a child, wargames as a teenager, so why not try this strange and rather beautiful board game? Someone offered a cursory explanation of the rules, and I duly proceeded to come fourth out of four players. But it was fun.
The Settlers of Catan superficially resembles Monopoly. The board is assembled from hexagonal tiles, but the components include wood houses that look much like Monopoly buildings. The idea is similar, too: players use resources (money in Monopoly; timber, wool and other commodities in Settlers) to build property; the property then collects further resources, and the process of expansion continues.
Yet after Monopoly, Settlers was a revelation. Monopoly ends in the slow strangulation of the weaker players and usually feels stale long before the official end, assuming it isn’t abandoned along the way. Settlers didn’t take long – perhaps an hour – and even as it was coming to an end, every player was still involved. In Monopoly, many choices can be made on autopilot; in Settlers, there is scope for skill throughout a game: the decisions always matter and are always interesting. Settlers has its own elegant economy, in which the supply and demand for five different commodities are determined by tactics, luck and the stage of the game. Players constantly haggle, wheedle and plead. It’s convivial experience, a game of incessant banter. In the course of an evening, I was hooked.
Settlers is the game that brought “German-style” or “Eurogame” board games to the attention of an English-speaking audience. The board game market in Germany is more like the book market in other countries: several hundred new games are launched there every year – typically either at Essen’s Spiel convention in October or the Nuremberg Toy Festival in February – and each year, at least one new game will sell hundreds of thousands of copies, perhaps millions, as Settlers has. There are evergreen games, briefly fashionable sensations and flops.
“There are two schools of thought as to why the Germans love board games,” says Martin Wallace of Warfrog. “The Germans are of the opinion that it’s down to their superior education system. We English are of the opinion that it’s because German TV is shite.”

…

There are, in fact, many more than two schools of thought about why Germany is the world’s board game superpower. It could be the enthusiasm of the citizens. In a country such as Britain, it is downright odd to pull a board game out of a cupboard and offer to teach it to friends alongside after-dinner coffee. In Germany, people do that and more. They discuss old games and act as evangelists for new ones. Naturally, the games are better as a result.
The cause could also be Germany’s pluralistic gaming tradition: most countries play games, but German gaming has never been dominated by a single game – unlike Japan (Go) or Russia (chess). But it could also be the influence of a single pioneer, Erwin Glonnegger. Born in southern Germany in 1925, Glonnegger joined the publisher Ravensburger after the war, where he became its first board game “editor”, working with designers through the 1950s and 1960s to produce a series of elegant games now considered timeless.
By the late 1960s and early 1970s, German newspapers were running columns about “family games”. There may have been a social motive – board games were, and still are, regarded as a wholesome activity – but the columns reflected the genuine enthusiasm of mainstream journalists who persuaded their editors to let them moonlight as game critics. In 1978, those enthusiasts decided to create an award, the Spiel des Jahres (Game of the Year). The first prize was handed out in 1979, to Hare & Tortoise – ironically, an import from England. And it is in England that the world’s most prolific game designer now lives.

…

Reiner Knizia, the winner of “Spiel des Jahres” for both adult and children’s games in 2008, designs almost 50 games a year. He puts on a suit and tie every morning, then steps into his office in the sitting room of his home in Windsor. His filing cabinets are packed with the fiddly paper prototypes of nascent games, his mantelpiece stuffed with awards. A secretary assists his work.
I suggest to him that neither he nor his industry can keep up the pace, especially given the competition from a constantly innovating computer-games business. But Knizia dismisses the idea that the board game industry is running out of steam. “After 2,000 games, it’s hard to make the 2,001st game on the same lines, sure,” he says. “But the times evolve and the games evolve with them. The classic games are slow-moving, they have a slow build up. The new games are different, they’re much faster.”
As one of the few professional game designers working full-time, Knizia says he is able to offer publishers a range of related products – here a franchise game (The Lord of the Rings board game is Knizia’s bestseller), there a card game spin-off or an expansion set. He’s also interested in the latest technology. He designed a game using electrically conductive paint and playing pieces with computer chips inside them, so that the board can talk to the players. He describes his latest explorations, investigating the potential of ultraviolet paint and ultraviolet light – “ultraviolet lamps are now so cheap” – to reveal hidden information during play.
But this prolific pace might be part of a problem. “There are just too many games,” says Mark Kaufmann of Days of Wonder, maker of Ticket to Ride, a railway-based game and Spiel des Jahres 2004. Even in Germany, “the market can’t handle all the titles. Distributors and stores aren’t sure what will sell, so they keep stocking the bestsellers, games like Carcassonne and Settlers and Ticket to Ride, because they’re proven products. It’s a no-brainer. But that makes it hard for new games to break through.”
After decades of growth (Knizia guesses double-digit growth), the German gaming industry is slowing down. Martin Wallace of Warfrog describes Germany’s gaming market as “a slowly collapsing universe”; André Maack of the board game giant Ravensburger is more optimistic, but even he sees board games taking a growing market share of a flat hobbyists’ market.

…

At Essen, though, there is no sign of an industry in stagnation. And the business, while small-scale compared with movies and computers, or even books, is full of entrepreneurial characters.
In a makeshift office tucked away behind one of the stands, I met Jay Tummelson, who has done more than anyone to bring Eurogames to the rest of the world. A likeable, fast-talking and opinionated American in his mid-sixties, Tummelson owns the company Rio Grande Games. Its stand is almost as large as those of the industry giants, the Ravensburgers and Mattels, but there are no 20ft signs, stages, or gantries.
The stripped-down approach is emblematic of Tummelson’s business model, which is to produce a vast range of gamer-friendly, no-frills translations of German games for the English market. He does business with all the major German publishers, accepting their game design and artwork, sharing their production costs and adding his own English print run to the end of theirs – typically producing 2,000 English versions on top of the 5,000 German originals. Tummelson throws these games into a growing market and reprints at much larger volumes whenever he has a hit on his hands. And he’s had quite a few hits. Before founding Rio Grande Games, Tummelson imported Settlers – and he is responsible for producing the English versions of most recent Spiel des Jahres winners.
(When I met him, Tummelson was launching his first non-translated product, a fast-moving card game called Dominion. It was the talk of Essen and this English-language import promptly won Spiel des Jahres 30 years on from Hare & Tortoise.)
When I suggest to Tummelson that he has, almost single-handedly, brought German games to the rest of the world, he demurs. “I played my part, but the internet was by far and away the most important thing.” German games’ successes may depend on personal recommendations, but in the UK and the US, gamers are spread too thin to speak to one another directly. Ironically, rather than wiping out board games, computers have provided the connections for once-isolated games in the UK and US to swap ideas online and meet up over the gaming table.
Board game publishers long ago stopped fretting about computer games putting them out of business. “Everybody had that fear,” says Ravens-burger’s André Maack. “But the fear has simply been proven wrong. The computer games are everywhere and they’re strong. But we’re still here,” he gestures to the bustling hall, “and we’re still here, playing board games.”
At the Kosmos stand, Klaus Teuber is still patiently signing autographs and talking to fans. I lurk at the end of the queue and persuade him to go for coffee. We perch at a breakfast bar in the press centre while, in halting English, he explains why board games have withstood the onslaught of games consoles and PCs. “You can know someone for 10 years,” explains Teuber with some passion, “and the first time you play a game with them you see a side you never saw before. But when you’re playing a game on your PC, you’re just playing a computer’s artificial intelligence. This is a partner with no emotion. You can’t see the computer smiling. You can’t see the computer… what’s the word?” He presses his fists to his head.
“Get cross?”
“Yes. You can’t see the computer get cross. People miss sitting around the table together, interacting with each other, laughing, joking and talking. There’s a chance for both types of games to do well. But board games will survive. They fulfil a…” – he searches for the word again – “…a need.”
As with other board games, computers only seem to have strengthened The Settlers of Catan. There’s an online version of the game which connects players to other players in the same city. They start playing online, but often then arrange to meet over a gaming table somewhere in the real world.
Does Teuber believe that, as with Monopoly, people will still be playing The Settlers of Catan 75 years after its invention? “I think so,” he says quietly. “It is a part of mankind to play games. We played in the Stone Age. We played in Roman times. It’s an escape from the everyday grind. Every day we work hard and we make mistakes and we are punished for those mistakes. Games take us to another role where you can make mistakes and you don’t get punished for them. You can always start another game.”

Tim Harford is the FT Weekend’s Magazine’s Undercover Economist

First published in FT Magazine 17 July 2010

Board game bestsellers on Amazon
in Britain

1. Bananagrams
2. The Settlers of Catan, Game of the Year 1995
3. Dominion, Game of the Year 2009
4. Blokus
5. The Settlers of Catan 5-6 player extension
6. Carcassonne, Game of the Year 2001

in Germany

1. Dixit, Game of the Year 2010
2. Dominion, Game of the Year 2009
3. Who was it?, Children’s Game of the Year 2008
4. The Magic Labyrinth, Children’s Game of the Year 2009
5. Ubongo
6. The Settlers of Catan, Game of the Year 1995