How knowledge transmission should work

The tenth anniversary of the UK’s 2003 decision not to join the Eurozone has just passed. With all my complaints about how bad macroeconomic policymaking has been recently, I thought it was worth analysing an example of a good decision. Good not just because it was the right decision given the events of the last few years, but good also because of how it was done, and the way academic knowledge was used.

If you want detail on the background and process itself, I recommend viewing or reading a recent lecture by Dave Ramsden, who was the civil servant who masterminded the process. Here is just a short summary. The UK opted out of being one of the founding members of the Eurozone, but the possibility of us joining shortly afterwards was always taken seriously. The Chancellor Gordon Brown announced 5 tests that would need to be passed if this were to happen, and the Treasury spent a couple of years doing extensive work on these five tests. It eventually published 18 studies, which I recommend to any students who want to take a serious interest in Optimal Currency Area (OCA) theory. Although there is some original work there (of which more later), they were mainly very good summaries of the relevant academic literature, and various academics were consulted to help ensure this was the case.

I should declare an interest here. I wrote one of those studies, which tried to assess what exchange rate the UK should join at, if the decision was yes. However I do not think this has any influence on what I have to say below, because in an important sense my study was secondary to the question of whether we should join. [1] In contrast, much more critical was modelling work done by Peter Westaway, at the time a Bank of England economist who had previously built the Bank’s core macromodel.

Now some will argue that these 18 studies, and the years of work that went into them, were window dressing for a decision that had already been made. I think that is simply incorrect. Some of the reasons I think that are described by Dave Ramsden: if the politicians involved had already made up their mind, they went to quite elaborate lengths to conceal the fact from those that worked for them. (Compare this to the Iraq war, for example, where a dodgy dossier sufficed.) Furthermore, the studies themselves contain some very strong arguments (probably too strong) why joining the Eurozone could be very beneficial, which is not the kind of thing you do if you want the analysis to back up a foregone conclusion.

As a result, I think the exercise was what it purported to be: an attempt by civil servants to give the best advice they could to politicians. What marks it out for me was the extent to which those civil servants involved academics, and placed academic work at the centre of their analysis. The merits or otherwise of the Euro did divide macroeconomists, but there was no attempt to just consult those who agreed with some predefined view. (See, for example, the space given to Andrew Rose’s empirical work of the benefits of OCAs.)

So why was this process close to what I consider an ideal of how academic knowledge should be used, when I have just written a post which is far more pessimistic about how these things are generally done? I should think about this some more, but here are three ideas. The first is that the decision, although it generated strong opinions on either side, was not fundamentally ideological. There was no existing political apparatus that was clearly aligned with potential winners and losers. The second is that you had a Chancellor who had a very strong respect for economic ideas, whatever else you may think of him as a politician. Third, the Chancellor had to convince the Prime Minister Tony Blair, and so whatever decision he came to needed to be backed up as strongly as possible.

Most people would now agree that the 2003 decision (only one the five tests were passed) was the correct one. [2] While the analysis, and particularly the work by Westaway, contained some of the elements that came to the fore in the Eurozone crisis, I think Ramsden in his 10 year retrospective is clear that the 18 studies also failed to foresee other elements of the crisis, perhaps not surprisingly as most macroeconomists missed these too. Yet the deeper point is this. The decision was based on the best analysis that macroeconomics at the time could provide. It is a shame that this way of making economic decisions now looks like the exception rather than the rule.  

[1] If anyone ever asks whether I can keep a secret, I always give this as evidence that I can. The original work I did for the study was done and written up in 2002. At the time the Euro/Sterling rate was at or near 1.6 E/£, and my analysis suggested something closer to £1.4 E/£ was sustainable. So for nearly a year I sat on information that was extremely market sensitive, and I received plenty of phone calls trying to extract any hint at what my analysis would be, and I’m glad to say no one got anything out of those calls. Alas I also felt it would be improper for me to bet on my own analysis, which had been funded by the Treasury - perhaps that just makes me an honest fool. (The morning my study was published - by which time the rate had fallen to much nearer my numbers, naturally - it did move the market by about one percent, but that is another story.)

[2] Will Hutton disagrees. In his counterfactual where we joined, the UK not only does better before the crisis because sterling stays at a competitive rate, but also the UK’s benign influence provides a counterweight to Germany. This alternative history deserves a proper analysis which I do not have space for here, but my initial take is that it involves a lot of wishful thinking.