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Bank bail outs are no model to follow for British steel

Bank bail outs are no model to follow for British steel

The potential closure of the Tata steel plants, and the plight of Port Talbot is a tragedy for those directly affected. A key question is: if the banks could be saved, why not steel?  From a purely political perspective, the topic has legs.  The loyal, hard working Welshmen, fearful for their families’ futures, contrasted with the arrogant pin striped bankers, ripping everyone off.  It is a difficult narrative for the government to counter.

Away from the hurly burly of politics, the challenge takes us to some issues at the very heart of economic theory. Economics for beginners starts off with a simple diagram showing how much firms would supply of a product at different prices, and how much consumers would demand.  The point where these two curves cross tells us the price which exactly balances supply with demand.  In the technical phrase, the market clears.

A fundamental question in economics has been whether it is possible to prove that a set of prices can be found which would clear every single market, so-called ‘general equilibrium’. Supply and demand would be in balance everywhere, and so there would be no unused resources.  It is a problem which is easy to state, but exceptionally hard to prove.  No less than seven out of the first eleven Nobel prizes were awarded for work in this area.

Readers may recall having to solve quadratic equations at school. It has been proved that there is a formula which solves every such equation.  Plug in the numbers, and out pops the answer.  The general equilibrium problem is similar, but at a much harder mathematical level.  Can some formula, as we can think of it, be found which proves that a set of prices can be found for every economy?

The work may be esoteric, but it has great practical influence. Much of regulatory policy, for example, is designed to try and remove impediments to the workings of markets, to try and bring about the desired state of general equilibrium, where all resources are fully utilised.

A crucial problem for this work, in many ways the crown jewel of economic theory, is that it has proved very hard to establish that money has any special significance. It is simply another commodity. This thorny theoretical issue was highlighted by the financial crisis, which the mainstream, equilibrium models could not explain. In essence, both money and steel are equally as important.  Economists will realise I am compressing points here, but in this framework if the banks can be saved so, too, can steel.

Economists not obsessed with equilibrium, like Keynes, often take a completely different view. Money is decisively different, because it is the only product which appears in every single market.  Disruptions to money are not confined to a particular part of the economy, but have an impact everywhere.  Milton Friedman believed that the Great Recession in America in the 1930s had a monetary explanation for this very reason.  Money is fundamentally different to steel.  The banks had to be saved, steel is just an option.

Paul Ormerod

As published in CITY AM on Wednesday 6th April 2016

Image: Steel by Ben Salter licensed under CCY BY 2.0

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