Prisme N°18

André Orléan

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The current financial crisis stems from a massive under-estimation of mortgage risks, particularly of the subprime kind. This essay seeks to understand the origins of such an error. Economists most often advance the perverse incentive structure as the cause. This is a valid point, but it only provides a partial explanation. This text explores another hypothesis: the difficulty inherent in predicting the future when agents face uncertainty of a Knightian or Keynesian type. It seeks to show that economic uncertainty is of this type. Probability calculus cannot be applied to it. For that reason, economic uncertainty evades the only available method of prediction: statistical inference. Consequently, in a Knightian world, there is no such thing as an objective evaluation of risk. This point is illustrated by examining the case of the US presidential elections of 2000.

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Prisme N°17

Nicole El Karoui, Michel Armatte

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Probabilists are often interested in the history of their discipline, and more rarely by the fundamental questions that they could ask about the facts they model. Works like Augustin Cournot: Modelling Economics, and especially the chapter by Glenn Shafer, throw light on some of my experience in the domain of probability over the last 40 years, which began in 1968, at the end of the first year of my Ph.D. They have prompted me to present my own point of view here.

I had the good fortune to participate in an extraordinary moment in the development of probability, more precisely the theory of stochastic processes. This was an unforgettable period for me. At the time, I had the feeling that I was witnessing science — probability theory — in the making. Subsequently, (rather by chance, it must be said) I switched over to the side of probability users, about 20 years ago, by focusing my research on one particular sector of finance. In the present text, I shall try to explain what interested me in the approach and in this aspect of finance on which I am still working today. To begin with, my account will be that of a pure probability theorist, and then that of an applied probabilist.

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Prisme N°16

Pierre-Charles Pradier

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Condorcet proposed a principle of reasonable probability: actions entailing a prohibitive risk with a non-negligible probability should not be taken. This principle guides the development of knowledge as much as it guides the action itself. The mathematics developed by Laplace has allowed for the effective application of this principle in mathematical statistics (point estimates combined with a high confidence level) or in the management of insurance companies (calculating the loading rate to ensure the solvency of the company). During the same period, Tetens was developing related ideas – though with less mathematical efficacy. These ideas from the 18th century still apply today, both in (the interpretation of) certain modern decision models and in the informational and legal requirements that should be enforced to ensure that financial decisions are rational.

Prisme N°15

Vincent Bignon, Yuri Biondi & Xavier Ragot

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European legislation took its essential inspiration from the logic of historical cost: the valuation of balance-sheet assets was grounded in the depreciated historical cost of their acquisition. In July 2002, the European Parliament’s adoption of new accounting standards for quoted companies, which took effect 1 January 2005, oriented European accounting towards the new principle of fair value. Its introduction has imposed the determination of the value of assets by the present value of the expected profits that these assets can generate. It has involved establishing the value of each asset according to its future contribution to the profit of the business.

Contemporary research, however, does not have as its ultimate goal the replacement of historical cost by fair value. Recent work analysing business production processes plead, on the contrary, for limitation of its usage. Three concepts summarize this work: asymmetry of information, complementarities, and specificities of assets employed. Firms create wealth by making assets complementary, because they add to these assets characteristics specific to the production process deployed. These supplementary characteristics have no market value, and thus the value of each asset for a firm is always greater than its resale value. Consequently, the specificity of an asset is defined by the difference between its value for the firm and its market value. In order to preserve the competitive advantage flowing from this combination of specific assets, it is necessary to keep this type of information secret: hence, there exists an asymmetry of information between the firm and its environment.

In this context, the criterion of fair value poses important problems of asset valuation: the specificity and complementarity of assets force accountants to use valuation models in order to determine asset values. Financial analysts have recourse to such models in order to value businesses. The use of these models for accounting purposes does not, however, ensure the reliability of accounts; in effect, small changes in the assumptions can lead to large variations in the results. The purpose of accounting is rather to constitute a source of independent information, in a form that is relevant to valuation by financial markets.

In addition to the valuation problem, the principle of fair value may introduce the problem of financial volatility into accounting. The existence of excessive financial market volatility, which is demonstrable theoretically and empirically, creates superfluous risk and tends to reduce the investment capacity of firms. Lastly, fair value reinforces financial criteria to the detriment of the other valuation criteria of management teams. All stakeholders in the business, including shareholders and institutional investors, risk being its victims.

The financial crisis that began in the summer of 2007 confirms the intrinsic flaws of the fair-value accounting model. It did not help to prevent the crisis, but rather deepened it. Accounting must be an instrument of control and regulation, independent of the market and centred on the firm as an enterprise entity, without following daily market values. Accounting must thus establish itself as a central institution of market economies, essential to the functioning of the markets and in accordance with the public interest.

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Prisme N°14

Bernard Gazier

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This short essay explores the apparent paradox of the “working poor” – persons remaining in poverty despite their working status. While it seems that the existence of the working poor is an inescapable by-product of capitalism, the size and modalities of this phenomenon vary considerably among countries.

The first section examines the various definitions of the working poor. Although great efforts have been made to gain a better statistical understanding and measurement of the working poor, researchers and governments are far from agreeing on one single definition. On the contrary, a set of different approximations, mixing low earnings, family composition and tax effects, are necessary for capturing what is a hybrid reality. The second section is devoted to a critical assessment of some selected empirical and comparative studies on Europe. They confirm the strong diversity in possible definitions, as well as in national situations and developments. They also suggest that a major role is played by institutions, not only transfers, but also the segmentation and organization of the labour market. The last section presents different theoretical perspectives on the working poor. It insists on the functional role played by low wages and the activation of social policies in jointly controlling the labour market and the workforce. Some public policy issues could contribute to mitigating this functional role.

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Prisme N°13

Robert Boyer

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Finance can contribute to growth through various mechanisms: the transfer ofsavings from lenders to borrowers, the smoothing of investment and consumption profiles over time or again the transfer of risk. Financial innovations have their own characteristics: the result of private profit-seeking strategies, new financial products can spread very fast, because their production process is immaterial. This rapid diffusion can have a significant impact on macroeconomic stability. Financial history shows that the effects of financial innovation, ultimately favourable to growth, materialize through a succession of crises and efforts at regulation to avoid their repetition. Historical analysis, unlike the theories that postulate the stability and efficiency of financial markets, also allows us to detect the emergence of financial crises. The crisis triggered by the subprime mortgage meltdown is no exception. The sequence:
“private financial innovation, diffusion, entry into a zone of financial fragility, open crisis” does not stem from the irrationality of agents’ behaviour. Is it then possible to avoid a financial crisis? Why not apply the same sort of certification procedures to financial innovations as we impose on food products, drugs, cars, public transport, banking and insurance? Up until now, the omnipotence of finance has prohibited any such public intervention.

Prisme N°12

Thomas Heams

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Biology has long been dominated by a deterministic approach. The existence of a genetic code, even a “genetic programme”, has often led to descriptions of biological processes resembling finely-regulated, precise events written in advance in our DNA. This approach has been very helpful in understanding the broad outlines of the processes at work within each cell. However, a large number of experimental arguments are challenging the deterministic approach in biology.

One of the surprises of recent years has been the discovery that gene expression is fundamentally random: the problem now is to describe and understand that. Here I present the molecular and topological causes that at least partly explain it. I shall show that it is a wide-spread, controllable phenomenon that can be transmitted from one gene to another and even from one cell generation to the next. It remains to be determined whether this random gene expression is a “background noise” or a biological parameter. I shall argue for the second hypothesis by seeking to explain how this elementary disorder can give rise to order. In doing so, I hope to play a part in bringing probability theory to the heart of the study of life. Lastly, I shall discuss the possibility of moving beyond the apparent antagonism between determinism and probabilism in biology.

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Prisme N°11

Edouard Challe

Also available in German

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This article examines the way in which fiscal policy impulses (variations in government spending and tax cuts) affect aggregate variables such as GDP, consumption, investment and employment.
Economic theory distinguishes three potential channels of transmission for these impulses, according to whether they affect the equilibrium through their wealth effects, their aggregate demand effects, or their liquidity effects.
We therefore intend to evaluate the extent to which these theoretical channels are consistent with the empirically observed impacts of fiscal stimulus. Although economists have traditionally focused their attention on wealth effects and aggregate demand effects, traditionally associated with the “classical” and “Keynesian” paradigms, recent works on the subject show that liquidity effects also play an important role. Finally, in the presence of aggregate demand effects and liquidity effects, fiscal stimulus is all the more effective over the short term when it is financed by government debt issue. The gains achieved through debt-financed stimulus can, however, conflict with the social costs resulting from high levels of long-term public debt, and this raises a specific problem concerning the dynamic consistency of fiscal policy.

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Prisme N°10

Masahiko Aoki

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How should one interpret the changes in Japan’s company structure that have been affecting the Japanese economy since the early 1980s? This text proposes a conceptual framework from the firm’s point of view, after examining empirical evidence. Has Japan’s corporate governance made a substantive institutional transformation, and, if so in which direction? Four stylized analytical models of corporate governance are presented, and the conditions in which each would be viable are identified.

Using this theoretical background, the text examines the driving forces, as well as the historical constraints, of the changes taking place in Japan. The nature of the on-going institutional changes in Japan’s corporate governance can be interpreted as a possible transition from the traditional bank-oriented model to a hybrid model, built on the combination of managerial choice of business model, employees’ human assets, and stock-market evaluations. No single mechanism has emerged as dominant, but a variety of patterns seems to be evolving.

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Prisme N°9

Évelyne Serverin

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Community law has created a fiscal territory by using a series of legal techniques founded on different parts of the Treaty. By dividing Europe’s complex legal structures into five categories of action, we seek to elucidate the foundations, and nature, of EU tax policy. We can separate these legal techniques into two groups, depending on whether they involve taxation, in the strict sense of the word, or other rights and liberties.

Three actions are directly associated with taxation: prohibition, harmonization and approximation. Two other actions do not affect substantial tax law, but influence its application: guaranteeing the exercise of fundamental liberties and informing the Member States. We shall evaluate the relative weight of these two groups of actions through an analysis of the instruments available to the Community and their associated jurisprudence.

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