You can also read this column on the FT website by following this link.
My word, these young students can be so tiresome – ask them to look at a subject where received wisdom is well entrenched and you may find them coming up with an entirely fresh answer, not the one which everyone else currently takes for granted. The young postgraduate student at the University of Massachusetts who was asked, but failed, to replicate the calculations of Rogoff and Rinehart about the relationship between debt levels and GDP has surely earned himself a small footnote in the history books for his part in the unseating of austerity as the default policy response to the global financial crisis.
It is hard to think of another seemingly humdrum research exercise which has had such immediate or far-reaching political consequences, notwithstanding that the excitement and animosity which the revision of the two authors’ findings has engendered in the world of academia is quite difficult for anyone outside that sheltered circle to comprehend. The traditional gibe that academic disputes are so vicious precisely because the subject matter is so trivial clearly does not apply in this case. Only last week Rinehart and Rogoff felt obliged to ask their chief antagonist, the economist Paul Krugman, for an apology for what they saw as his bad manners in seizing on the minor technical errors in their paper with such ferocity.
As far as I can see, the revisions which the two academics have made to their original work do little to change the thrust of the original argument. The idea that exceptionally high levels of debt tend to be associated with lower rates of economic growth remains as broadly (and perhaps as obviously) true as it was before. Whether or not a 90% debt to GDP ratio is a critical threshold in that relationship is a secondary issue, but its evident relevance to many countries’ current policy dilemmas has endowed it with a much wider influence than it would have attracted in more normal times.
The prominence given to the Rinehart and Rogoff analysis is explained, in part at least, by the fact that current economic conditions are so unusual and the policy response to them necessarily so unprecedented in scale and ambition that policymakers are grasping at any empirical crutch they can find, trusting to – rather than analysing carefully – the rigour of its foundations. Officials at the Bank for International Settlements has been vocal in recent months in emphasising how central banks are having to pick their way through uncharted waters, given the scale of the financial crisis that unfolded five years ago and the inadequacy of the political and fiscal response it has so far engendered.
It does not help that the economic data on which policymakers have to rely has ceased to repeat past patterns in a number of crucial respects, prompting Charlie Munger, Warren Buffett‘s longstanding business partner, to say at this year’s Berkshire Hathaway meeting: “If you are not confused about the economy, you don’t understand it very well.” Just as the seeds of the financial crisis were ultimately rooted in the failure of conventional thinking to anticipate the consequences of a massive credit build up – operation inflation targeting worked, but the patient still died – so too we are all now paying the price for the absence of a coherent and convincing policy rationale for how best to escape from its painful aftermath.
The importance of giving received truths to fresh young minds to review can have implications in other fields too – fund management included. Terry Smith, the founder of the Fundsmith fund management business, told me recently how he struggled to find a useful template for designing the ownership structure of his new business, given his desire (a quixotic one, some will doubtless say) to minimise the agency problems that continue to bedevil the fund industry in a number of different ways.
In essence the problem, as he sees it, is how to establish the incentives within a fund management group so as to align as closely as possible the interests of the investors and the managers, when in practice so often the two are negatively correlated, with both groups competing, in effect, for a share of the cash flows which a fund’s investments produce. As Jack Bogle has chronicled, the conflict has intensified dramatically since a landmark ruling in 1958 allowed managers to sell (and capitalise) their mandate to manage the funds in their care. Somewhere along the way fiduciary duty to fund investors has become secondary to the more powerful commercial obligations that many fund managers feel they owe to their shareholders, whether themselves or outside investors.
Mr Smith found his own answer (a carefully drafted partnership structure that explicitly prevents him from selling his majority interest in the fund management group) in a surprising place, in a report by a young graduate student called Mike Walker, which the latter produced (without remuneration) for the Wilberforce Society at Cambridge University. The society bills itself as a student “think tank”, one that encourages students to tackle big topics, taking advantage of the fact that they are “rarely restricted by dogmatic thinking, offering instead a freshness and originality of thought”.
As well as highlighting the need to tackle the conflicts inherent in ownership arrangements, the commendably short report (available on my website www.independent-investor.com) emphasises the need for fund managers to take more seriously their obligations as stewards of other people’s money. Given how little traction Buffett and Bogle’s strictures on the fund management business seem to have had over the years, I dare say it won’t shape the world in the same way as Rinehart and Rogoff have done, but no harm will be done by reading how this industry appears to a younger, not uncritical observer.
Footnote: The report I mention can be downloaded from this Wilberforce Society link. I have learnt subsequently that its author is now in his 30s, so a mature graduate student rather than an entirely fresh-faced young man. Nonetheless his perspective is still worth reading….