 Gwyddoedd yn ymwybodol, dyma'r Pwyllwebly. I'm y director of science. I'd like to welcome all of you in the audience tonight, particularly those who've travelled a long way to be here, and to Professor Christian Alton's friends, colleagues and family. Brother and sister and cousin are here. I don't know where they are in the audience, but I've been told they're here. There they are, hello! I particularly want to welcome those who's not here in absentia, your mother who celebrated her 89th birthday recently who can't be here but is going to watch it later. So a great welcome to her. We've got guests from many people here tonight. Some of you have come a long way. We're very grateful to you for coming. Science and all rules are real occasions. Of course, there's ceremonies you could see were dressed up in gowns. That's what makes it a ceremony. It's also a reaped passage for the speaker. Christian, of course, has been a professor here for some time and was a press professor elsewhere, but it's still a reaped passage. It makes her into a psoas professor. It's also a celebration, an intellectual celebration, and it's an enjoyable event for all of us. To make sure it's an enjoyable event, I just need to do a little piece of housekeeping at the outset. I'm going to model this for you, so turn off your mobile phones first, which is something I always forget to do. Gosh, what have I done here? I put it on speaking clock. That's clever, isn't it? Right. Do note where the fire exits are. There is no fire alarm planned, so if the fire alarm goes, that tells you there's a real fire, and please leave promptly. I'm very pleased to preside over this inaugural lecture. It's the third of the 2012-13 inaugural lecture series. I'm really looking forward to it, and most of my discussions with Christine, because she's a head of department, are about administrative and management issues, in which she displays great acuity and focus, but I don't get to talk to her about academic things, so I'm looking forward to anticipating those qualities in her talk on complexity and diversity systems of finance innovation ecology. Christine will be introduced by Professor Lawrence Harris. Many of you here will know Lawrence, because he's a professor of economics here at SIS, and before he founded the Centre for Finance and Management here at SIS, he taught at LSE, and we were just establishing earlier when I was complaining about the teaching of economics that I'd received as an undergraduate at LSE, that he himself had not actually been responsible. Gwlyffinus in California, Berkeley, Harvard, Birkbeck, the Open University, University of Zimbabwe. He's been a visiting scholar at the University of Cambridge and the International Monetary Fund. I'm not going to say anything more about you, Lawrence, because everyone here knows. The vote of thanks will be given by Professor Giorgia Giovannetti. She's a professor of economics at the University of Florence and a part-time professor at the European University Institute, where she's acted as scientific director of the European report on development in 2009 and 2010. She's directed the research centre at the Italian Trade Institute. She's also been an advisor for the Italian Treasury. That sounds like a real challenge. And the Ministry of Foreign Trade. She holds a PhD in economics from the University of Cambridge, as well as an employee in economics from the University of Cambridge, and a Laura Ecom Laude from La Sapienza University in Rome. Her research interests include macroeconomics, political economy, international trade, and development economics. We're very grateful to both of you for being here this evening and being part of the event. At the end of the event, and Giorgia will remind you of this, at the end you'll be invited upstairs to a reception in the Brunais Suite for some wine and other refreshments. So to introduce Professor Outon, I will pass over to Professor Lawrence Harris. Over to you, Lawrence. Good evening, director, colleague, students and guests. It's a great honour for me to introduce Professor Christine Outon as Professor of Managerial Economics and Head of our Department of Financial Management Studies. A brief introduction really cannot possibly do justice to Christine's extensive academic achievements, but I hope to convey their essence while we eagerly await Christine's own explanation in her inaugural lecture of the view from the cutting edge. I first knew Christine through her work. In 1993, an article by Christine and her co-author Kirsty Hughes was published in Economica, with the title, Diversification, Multimarket Contact and Profitability. A category title? Well, perhaps, but in some ways it was, I felt it was a modest title that did not really suggest fireworks. But the article, nevertheless, made me sit up. It caught my attention because it refuted the then widely accepted theory that the creation of corporate conglomerates with diversified products, such as the behemoth that was constructed and celebrated by that era's city hero, Lord Hanson, yields economic benefits to society, as well as to the owners. In fact, the research had showed that UK conglomerates' potential gains in production efficiency can be and are counted as a result of having more complex relations with markets than the textbook ones. But for me, the article stood out for another reason. Alton and Hughes' research approach itself, the research approach that they used, rigorously carried out with mathematical and statistical elegance. It differed from the then fashionable type of research that was hitting the headlines. In the late 1980s, while Christine at Glasgow University in her first lectureship was doing the research that led to the 1993 article, the headline issues engaging economists in Britain were macroeconomic. Monetarism and its critics still reverberated and big-ticket research wrestled with large aggregate categories, the nation's GDP, inflation, unemployment, the money supply or the interest rate, and research papers were based on readily available, already published data. I, too, was working on macroeconomics and money, dealing with those intangible categories and others even less tangible, such as surplus value, remember? But I noticed that from that young researcher at Glasgow, something very different appeared. Instead of dealing with broad aggregates, Christine's 1993 article looked at the characteristics and behaviour of individual UK firms and built up from that basis. Instead of using readily available numbers for the economy as a whole, Christine constructed the raw numbers themselves by digging into every possible source of information, including even trade directories and the rather imperfect company's accounts of individual companies. To make the data usable, she constructed a weighted index of a key but previously under-regarded variable, that is, firms' multi-market contacts. The index itself rapidly became adopted as a standard measure by subsequent researchers in industrial economics and management. And instead of relating the data sample to well-established theoretical models, Christine and her co-author based their estimates on innovative theoretical modelling of firms' behaviour in markets, taking entirely new approaches. They developed insights into how the individual agent, the firm, behaves in its complex environment, colluding or competing across many markets. To use a term that has come to prominence now in today's cutting-edge research, she had developed agent-based theory. It's one of the elements of today's complexity theory. Long before complexity theory became a recognised approach. That's the beginning, but there's been a lot since then. Some great scholars spend their lives reworking details of their seminal paper on monograph. Christine took a different path. She had the breadth of vision to initiate research on a wide variety of issues, issues with great policy significance. Over the following two decades, that research has generated a library of admired books and articles. Like the subject of her inaugural today, finance, innovation and ecology, Christine's publications since 1993 have engaged with topics that at first sight seem unconnected. But the integrity of Christine's research but the integrity of Christine's research has ensured that in each project's DNA were genes that could be traced back to that 1993 article on conglomerates. I shall mention a few of the research subjects for which Christine has been honoured. Christine has been honoured, has been awarded a stream of prestigious research grants directed to public advisory posts. First, corporate governance. Christine has co-authored a string of important publications emanating from her research on corporate governance. She then made another splash by pioneering research on the corporate governance of English football businesses. I say businesses despite the fact that for some strange reason they are still known as football clubs. Based on that research, Christine and her colleagues developed policies for reforming the governance of that powerful but strange industry and has continually been commissioned to advise official bodies and other authorities on it. Innovation. While the grand theorists of economics pinned their colours to the Austrian idea that innovation results from pure entrepreneurial spirit and is pushed forward by economic crises and competition in waves of creative destruction, Christine and her colleagues took a different approach to innovation. Developing principles rooted in the traditions of systems analysis, they got down to the granular details of how innovation actually proceeds in actual economies. Focusing in particular on how innovation is concentrated in particular regions, they showed the role of well-structured support systems as regional systems of innovation. They showed that co-operation in regional networks combined with regionally strong education systems and other regional supports. Instead of anarchic individualistic competitive destruction, competitive creative destruction, those regional innovation systems are the potentially powerful basis for innovation. The article by Christine and her collaborators in regional studies 2011, the article called regional innovation systems, theory, empirics and policy, defines the field. And it's one of that journal's most cited articles surpassing even the article in that journal by the Nobel laureate Paul Krugman. The next field to which Christine turned was environmental sustainability. Innovation towards a low carbon economy is the greatest challenge of our age. Christine's work on innovation systems led naturally to her recent research on environmental sustainability. Once again, when faced with an intractable real policy problem, Christine has gone outside conventional theoretical frameworks. She investigated the ways in which outside the economics mainstream, complexity theory can enable us to understand environmental sustainability. Her article towards a new complexity economics for sustainability, that's a title I love, towards a new complexity economics for sustainability was published last week in the Cambridge Journal of Economics that undoubtedly have a definitive role. The next topic to which she turned, the financial sector, by now you will have noticed that Christine is never one to ignore a challenge. Having tackled one difficult problem after another, Christine and her colleagues have now turned to the monstrous model that is today's financial sector. But let me say no more. Instead, let Christine herself tell us how again taking an unconventional but rigorous approach her analysis links to the creative research on the other problems that she's always taken. Christine is renowned as a team player and a team leader. The evidence in black and white is the many names of co-authors on her publications. I'm delighted that many are here tonight. Although I'm embarrassed by not having time to mention all, I would like to acknowledge one of Christine's longstanding collaborators from Oxford, Professor Jonathan Meekie, who has also benignly watched our department grow over the years. Christine's team building has been accompanied by an enviably strong university career. From the beginnings as a lecturer at Glasgow University, Christine moved to a senior lectureship at the University of Birmingham Business School, where she was also director of the Centre for Research on Industrial Strategy, and she was then persuaded to join Birkbeck College's Department of Management, where she became professor of management and head of department. Christine joined Sirius' department of financial management studies in 2009, having been honoured with professorships and visiting professorships in the preceding decades at many universities, including Florence, Wisconsin, Notre Dame, and recently the University of Bolzano, Italy. By the time Christine had joined, by the time we had managed to persuade Christine to join us, the school's department of financial management studies had grown strongly as a postgraduate department since its foundation eight years earlier. But from her first day at Sirius, Christine has had a profound influence beyond her research prominence. She created and successfully led our first undergraduate programme, the BSc International Management China. And now, as head of department, is leading the creation of new foundations for our master's degrees by distance learning, which currently have 4,000 students around the world. All the while, continuing to build a strong research-led department, Christine takes her place within the proud history of Sirius. Christine joins Sirius as five decades after an earlier remarkable economist. 50 years before 2009, Professor Edith Penrose came to the school to found the economics department. And I am struck by some remarkable similarities. Edith had, like Christine, focused on the detailed study of the real world firms and industries. And, like Christine, had seen that the search for truth required her to go outside of the conventional theories and conventional research methods, dominating the literature. The magnum opus that resulted from Edith's work, the theory of the growth of the firm, has been so influential that a recent appreciation by Christos Petales of Cambridge University's Judge Business School revived it as canonical, and one of the most cited books in economics, business and management. Historically, women have been lamentably underrepresented in the senior ranks of the economics profession. Christine's professorship renews Sirius's reputation for turning to outstanding female economists for strong academic leadership, taking the school in new directions. And like Edith Penrose, there can be no doubt that 50 years hence, Sirius will be able to say we had a leader whose writings, canonical in fact, created new perspectives. It's my pleasure to invite Professor Christine Alton to introduce those new perspectives now and deliver her inaugural lecture, complexity, diversity, systems of finance, innovation and ecology. Good evening principal, Professor Harris, ladies and gentlemen, and distinguished guests. And thank you, Paul and Lawrence, for those very kind and generous words of introduction. I hope I can do justice to them tonight. I'd also like to thank the many colleagues I've been fortunate enough to work with over the years, some of whom are here tonight, especially Fiona Carmichael, a colleague from my very first research job at the University of East Anglia who's travelled here from Birmingham University today, and Terry Moody, who I worked with in my first lecturing job at the University of Glasgow who's travelled from Scotland. And also to my colleague and friend from my student days at Cambridge, Professor Giorgia Giovannetti, who joins us from Italy and who I've known now for over 30 years. And finally, I'd like to thank Katie Nugent and Peial Gagliani-Batt for organising this event so well. Much of what I'm going to say tonight is based on joint research, and I'm grateful to my colleagues, Bjorn Asim, Tim Foxon, Jonathan Kohler, Nicol Lander Basso, Jonathan Mickey, Helen Norton-Smith, Kevin Morgan and Lorraine Whitmarsh, all of whom have been great to work with over years and who have worked with me on some of the things I'm going to talk about tonight. So, in tonight's lecture, I want to consider three questions. How might we make financial systems more stable? What are the sources of innovation and prosperity and how we might reduce carbon emissions? This last one is extremely important if we don't address this problem. There could be severe consequences for future generations. These questions have been the subject of my recent research. They're actually the topics of my most recent three papers, two of which have just been published and one which is about to be submitted. And they may seem disparate. But I'll argue that a fourth question binds them together. And that question is, can consideration of complex systems theory and diversity help us understand these issues? The first of the three questions I've outlined are ones that I've focused on in my research because they're real problems that affect us now and are likely to do so in the future. In addition to being interesting theoretical questions, there's a practical need to find solutions, to find solutions to make financial systems more stable, to promote convergence in living standards across regions and to reduce carbon emissions and prevent global warming. To embark on the argument that binds these three questions together, that consideration of complexity and diversity can offer new insights, I will set out by way of background how conventional theory has tended to analyse these problems. Having done that, I will aim to show that thinking about complex systems theory and diversity might enhance our understanding. Finally, I will illustrate the argument by applying systems thinking to finance innovation and environmental sustainability. So that's the plan. Let's turn to this first term task of conventional analysis and the nature of the firm. At the heart of theories of the performance of firms, industrial sectors and economies, are basic questions about the nature of firms, be they banks, manufacturers, oil companies, shops or hotels. The conventional approach is to model firm or business behaviour by assuming a simple behavioural rule, profit maximisation. It is assumed the main objective of firms is to maximise their profit and if they are owned by outside shareholders and if we assume perfect information in stock markets, this amounts to maximising shareholder value of which there is a lot of talk in the financial pages of the press. Thus it's commonplace in economic and management theory to start by studying individual firms and then to assume that all firms, a representative firm, all firms behave in the same way as this representative firm. Firms have access to the same technology and supplies of capital labour so that we can think of our representative firm and aggregate up to the whole industry or the whole economy. We start off modelling the behaviour of a firm, assume a simple behavioural rule, it's a profit maximiser, it's motivated by a financial gain. Then we simply replicate this firm, the so-called representative firm. There's been an interesting paper by Kerman on who or what does a representative firm represent, but we replicate the representative firm and we can aggregate up to the level of the industry. According to this approach, it's critical they behave in the same way and the behaviour leads to market or macroeconomic outcomes. If we further assume, as Conventional analysis does, often perfect information, perfect competition and no barriers to entry or exit into or out of industries, then it's possible to show that profit maximising behaviour leads to an equilibrium outcome where supply equals demand on all markets. Having done this for one market, we can replicate it for all markets. That theoretical model that I've just described is a mathematical formalisation of Adam Smith's notion of the invisible hand. The formalisation took place well over one century after Smith described it in his Wealth of Nations and it led to Nobel Prize winning, one of the people working on it, with Arrow winning the Nobel Prize in 1972. It's a very significant body of research that I've just described. It was a formalisation of Adam Smith's invisible hand. Interestingly, although notion of the invisible hand is a popular concept, there is only one reference to it in the two volumes, five books and 1,079 pages of the Glasgow edition of Adam Smith's Inquire into Nature and Causes of the Wealth of Nations, but nevertheless it has captured economists and the popular imagination. The idea is as follows. It starts off from profit maximisation. It's only for the sake of profit that a man employs a capital in support of industry. By directing that industry in such a manner as its produce may be the greatest value, he intends not only his own gain and he is in this as in many cases, so he intends only his own gain and he is in this as in many cases led by an invisible hand to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of society more effectively than when he really intends to promote it. Just to reiterate the point, he goes on to say it's not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from regard to their own self-interest. In fact, Smith's notion of the invisible hand is a prime example of one of the key features of complex systems, that out of complex interaction between disparate agents, firms in this case, it is possible, though by no means inevitable, that simple patterns or order emerge. Another property of complex systems is that outcomes at the aggregate on macroeconomic level are often at odds with the individual intentions or behaviours at the microeconomic level. Adam Smith's invisible hand is an early example of this key characteristic of complex systems. Smith argued that the behaviour of greedy profit maximising firms did not, as one might expect, lead to chaos but to order. It led them to a situation where there's a tendency for supply to equal demand on all markets and where profits are competed away towards natural or normal rate of returns. This was an optimal solution for consumers and society. Embedded in Smith's invisible hand is another feature, a paradox, that everyone acting in their own self-interest leads to the common good. And that sounds too good to be true, doesn't it? And that's probably because it is too good to be true. Smith went on in a much less well-read volume 2 of the Glasgow edition of the Wealth of Nations to consider the role of the state as a provider of public works and public institutions such as the judiciary, the control of monopolies, the education of children and of youth and of adults, all of the things that are necessary to help markets work effectively. However, volume 2, book 5, has been largely ignored by the mainstream economics profession who turned their attention to mathematically formalising Smith's theory of the invisible hand. That body of research shows that the conditions necessary for Smith's invisible hand to operate are extreme. We need to assume many producers, so many in fact that each is tiny in the face of the market and is therefore unable to influence, have any influence over price. Firms are price takers, not price makers, and the market dictates to them not the other way round. We need to further assume that all firms behave in the same way. Moreover, all firms know this, that all the others are profit maximisers too, and so they can predict the behaviour of their rivals knowing it's the same as their own behaviour. We also assume that they all have access to the same technology, that there is perfect knowledge and perfect foresight. Finally, because we've assumed that firms find themselves, that firms themselves have no power to change prices. These are dictated by the market. In the mathematical formalisations we need to assume a fictitious auctioneer who adjusts market prices so that supply equals demand on all markets. Without an auctioneer, or some might say without a central coordinating device or planner, the market will not function in theories of general competitive equilibrium. If these assumptions hold, then it's possible to show that an economy with many agents modelled by a representative agent can converge to a competitive equilibrium where supply equals demand on all markets, where there's no unemployment, and where economic and social welfare is maximised. The problem is, of course, that in reality the assumptions don't hold and we experience markets not clearing with excess supply or demand, unemployment and financial crisis. Smith's invisible hand fails, a point that Smith was only too aware of. Smith's theory of the invisible hand illustrates an important feature of complex systems, namely that the behaviour of the system emerges out of the behaviour of the individual components that make up the system. An example of the invisible hand guiding greedy individuals to an outcome that is the opposite of their intention is an example of a well-behaved system that ends up maximising social welfare. However, there is no requirement on a system to be well-behaved. John Maynard Keynes also described a macroeconomic outcome based on rational self-interest in his theory of employment that is paradoxical. But unlike Smith's invisible hand, it does not lead to an outcome that is socially optimal. Rather, it leads to unemployment and welfare loss. He was, of course, writing at the time of the last Great Depression and he pointed out that inner recession or depression it makes sense for each individual firm to cut its production and employment. However, when all firms do this simultaneously, there's a fallen output and employment at the macroeconomic level that causes incomes to fall, leading to a further falling demand that necessitates our individual firm to make a further reduction in its production and output with the process continuing into a downward spiral that is known as the Keynesian multiplier. While the initial cut in output and employment was rational from the perspective of an individual firm, when all firms reason in the same way that actions are self-defeating and the economy tumbles into recession or bumps along the bottom and, I guess, we're all too familiar with that situation today. What I've described are some of the features of complex systems. Complex systems, though, tries to model this complexity by considering individual behaviour. Individual behaviour has system-wide effects that are sometimes the opposite of what agents or firms or consumers intend and they're counterintuitive. These effects may be positive or negative. Secondly, it looks at... it abandons the assumption of a representative firm or agent. Agents differ in their objectives and behaviour, so it allows for diversity. Thirdly, it looks at interconnections, and these interconnections don't just take between firms and between other actors in the economy, such as the government. These interconnections don't just take place through the market. They can also be non-market interconnections. Fourthly, it looks at the emergence of outcomes in a historical sense and it looks at evolution and change and dynamics. A particularly important idea or a couple of important ideas in complex systems thinking is something called path dependency that if we start along a particular path, it narrows off certain options and we're dependent on where we've been in the past in terms of the options that were open to us in the future. It also leads to locking where we can get trapped into certain technologies and certain kinds of behaviour and it can also lead to herding behaviour which is very common in financial markets. So if we look at some of these aspects, the interconnections and interaction between agents, one way and the idea of locking and path dependency, one way is to consider the QWERTY keyboard which was used as an example by Paul David who's written extensively on the notion of locking and the QWERTY keyboard was designed as I'm sure some of you know to slow down the speed at which people could type and that was because the first typewriters were mechanical and fast, the keys jammed. But we still use this keyboard today and we're stuck, we're locked into this keyboard and we're locked in because of a system effect and the system effect is that once you train people to type on this keyboard it becomes very expensive to retrain them. It's much cheaper to poach workers from other firms that know how to type on this system and invest in training inside your own firm to show people how to type faster on a new system. So the QWERTY keyboard explains two of the ideas really of complex systems so that we can get locked in to an inefficient technology like this keyboard and there's path dependency. It also explains another feature which is the free rider problem and the free rider problem is a problem in training. It's much cheaper for firms to poach workers from other firms than it is to invest in training themselves and so we've seen this cartoon that the firm doesn't want to invest in training partly because it fears their workers will leave and also because it hopes every other firm will invest in training and they can poach workers from other firms but of course when all firms think like this together the solution is or the outcome is that there's no investment in training and that is why governments tend to subsidise training in order to get out of this particular free rider problem. So those are some of the notions of complexity and complexity. What about diversity? We've seen that the conventional approach the study of economics and business is to start by modelling the behaviour of a representative firm agent, consumer to assume that all firms or consumers behave in the same way so that we replicate this firm many times in order to aggregate up to the economy as a whole. It may seem surprising to the lay student of economics that such scant attention is paid to the question of how firms differ in their objectives, their behaviour and their capabilities. Management theory has focused in particular on differences in firms' capabilities and still the dominant approach in much economics and management research is to reduce the behaviour of firms and consumers to a constrained maximisation problem such as profit maximisation or utility maximisation and to assume that all firms are motivated by the same thing profit and behave in the same way. However if we look at firms and economies we see that they are vastly different and that these differences persist between firms and across regions and nations. Most of us are familiar with the shareholder-owned PRC model that can be roughly characterised as a profit maximising firm but there are many other types of business organisations, family businesses, employee-owned businesses such as the John Lewis partnership which owns one of our biggest supermarkets. Mutual organisations, firms owned by their members or customers, for example the cooperative bank the nationwide building society which is in one of the top five biggest mortgage lenders. Charitable organisations, state-owned firms state-owned institutions and services the police, the judiciary, the civil service all of these things are necessary for a market economy to function. These different corporate forms have different objectives and behaviour. The mix of corporate forms in any economy results in different models of market economies the Scandinavian model with a strong welfare state the Anglo-Saxon model though there are significant differences between the US and the UK and the Chinese model of state capitalism so history hasn't ended quite yet. In any economy there are different types of firms and businesses and if we were to make progress on my three questions or problems I would understand this and study it rather than assume it away. Recognising complexity and diversity offers a way of doing this and since we can use agent-based modelling that allows different firms to behave differently it sheds new light. The disadvantage of this approach is that we will lose determinacy but in conventional theory we pay a very high price for determinacy. Conventional theory does provide an answer often in the form of an equilibrium solution with a price and output but it's a bit like the answer provided by the supercomputer deep thought in the book The Hitchhiker's Guide to the Galaxy. You may recall if you've read the book that when asked to provide an answer to the taxing question of the meaning of life the universe and everything deep thought reflected on this matter for seven and a half million years and came up with the answer of 42. The answer undoubtedly has precision and determinacy but of course it's almost devoid of any meaning. So with complex systems theory we will not normally attain convergence to a single equilibrium solution or a single answer. There will be different paths that an economy might follow depending on different agents and their behaviours. These are often modelled using simulations to give a range of outcomes rather than an equilibrium solution. Changing the type of agents or their behaviour leads to different economic outcomes for firms, consumers and societies. So let's have a look in more detail at an application of these ideas to the first of my topics the financial system and this is based on joint work with Professor Mickey. If we look at financial markets like the markets for retail deposits or the market for mortgages they are not controlled by one type of organisation. Broadly speaking the deposits market in the UK has been characterised by three types of financial institution and there are others actually that are smaller but these are the three main ones. Banks that are share hold are owned and maximise profits. Building societies and mutuals that are owned by their members and their objective in their articles of association is to maximise the welfare of their members or their customers and then we have the government owned national savings and investment bank which has a different objective to encourage people to save and to raise funds for the government. That's the historical picture we could of course add that we the taxpayer via the government now owns significant stakes in Lloyd's TSB and the Royal Bank of Scotland but we will put that issue to one side because while the government owns a controlling interest in two of Britain's largest banks that together account for a third of the market it is chosen not to exercise control and leaves them to their own devices. However the objective for mutuals and building societies is different it's not profit maximisation. They are very much to maximise the welfare of their members and their customers in practice this difference is very significant whereas the aim of the shareholder owned banks is to charge the highest interest rate profitable possible on loans and to offer the lowest rate possible on deposits in order to maximise the return for their shareholders the objective for the mutuals is to raise deposits and make loans normally for mortgages secured on residential property while only making a normal rate of return on their services so they are very service focused and their aim is not to maximise profit and they are going to price more keenly because of that and finally NS&I National Savings and Investment has still a different objective which is to encourage saving and fund government if we model a market like the mortgage market or the savings deposits market retail deposits market it would be quite wrong to assume one type of firm and one type of behaviour to recognise this business diversity which raises a question about how to do this there is quite an old literature that has almost disappeared it's making something a comeback called mixed oligopoly oligopoly is simply a market with a few sellers mixed oligopoly is a mixed market where traditionally there were two types of firm that were considered a private firm and a public firm firm that's publicly owned that operate in certain industries and we kind of know those industries don't we from the past you can see why this literature disappeared it's because of privatisation it can be shown that under certain conditions it's possible to attain the best of both worlds in a mixed oligopoly the dynamism that comes from private enterprise and the concern with social welfare that it's often the remit of public enterprise I would argue that we need to find a way of modelling oligopolistic markets to extend this to take explicit account of different types of privately owned firms insofar as they have different stated objectives and we can therefore expect their behaviour to be different in short we need to recognise the diversity in the financial services sector and allow banks and mutuals to follow different behavioural rules one maximising the profit and the other their members and their customer's welfare using this approach and assuming some constraints on the reach of firms over the market it is possible to show theoretically that the greater the mix of mutuals and banks the more diverse the financial sector the smaller the difference between the rate of interest paid to depositors and the rate charged to borrowers the smaller the profit margin of the shareholder owned banks the key interest rate we get is a deposit rate and the main interest rate we pay as borrowers is the mortgage rate the difference between these two rates is called the mortgage rate deposit rate spread and it's closely related to the profit margin that financial institutions make shareholder owned banks aim to maximise this spread or profit mutually owned banks aim to cover their costs including a normal rate return to their activities and this point has been made by Heffernan in 2005 and we can derive two clear hypothesis from modelling financial diversity in this way the first one is that the banks if their behaviour is really different would or should have a higher mortgage rate deposit rate spread than mutuals and the second one is that changes in the degree of corporate diversity in financial services will affect the size of the spread charged by banks so if we can imagine an industry where there's no mutuals the banks will have free reign to maximise their profits with the mutuals there they've got to compete with an organisation that is not interested in maximising profits it's interesting in providing maximising the welfare of their members and providing a value for money service to their customers so fall in diversity increase the spread for the banks it should really have no effect on the behaviour of the mutuals this is because the mutuals act is a form of regulation from within the industry offering services to their member in exchange for a normal but not excessive rate of return and so they're going to offer better rates for customers and curtail the excesses of the banks so what has happened if we look at the financial services sector this graph looking at the figure can be seen at the start of the period in 1995 the margins charged by the banks and the building societies were similar the margin or the mortgage rate deposit rate spread for the banks is in blue and that for the building societies is in red at the start of the period building societies was much bigger around over 50% and only one building society abynational had converted to a bank between 1995 and 2000 a number of building societies demutulised Charlton and Glouster, Alliance and Leicester Bristol and West, Halifax, Northern Rock Birmingham, Midshares, Woolwich Bradford and Bingley none of these exist today and of course you'll know that Northern Rock and Bradford and Bingley when they turned into banks they went on excessive spree of lending and borrowing in financial markets and collapsed changes in regulation allowed the building societies to convert to banks and the share of the mutual sector fell to around about 20% today this loss in corporate diversity has been associated with a rise in the mortgage rate discount rate spread for the banks more profitability for the banks other things being equal I mean other things going on with the banks and the data here end in 2007 because that is when the Bank of England ceased to publish separate data for banks and building societies nevertheless the data provide confirmation over this period that the mortgage rate discount rate spread for banks is higher than that in building societies the blue line is above the red line and these two types of business do appear to behave differently we can also see it there's been a rise in the margin or spread for the banks but over time but the spread for the building societies follows a more cyclical pattern though it clearly ends above its initial level so there's still below that of the banks we can superimpose on this graph a measure of corporate diversity the measure we've used is based on a measure devised by Simpson to measure biological diversity published in nature in 1949 it looks at the concentration of different types of species in our case different types of firm and subtracts this from one in order to attain a diversity index as can be seen corporate diversity has been falling in the financial services since the start in 2000 at the same time the profit margin or spread charged by the banks has been rising as they have attained a bigger share and as the market of the mutual sector has fallen and the banks have faced less competitive pressure there is a strong negative correlation between the degree of corporate diversity the purple line and the mortgage rate deposit rate spread set by the banks in fact it's minus 0.9 which is very high whereas for the building site the correlation between their spread and the degree of corporate diversity is very weak and it's only about minus 0.2 we would expect a weak correlation for the building site since their interest rate should be set at cost and be unrelated to nature of competition although there's a lot more work to be done and this is a work in progress our analysis suggests both theoretically and empirically that there's evidence that the banks and building sites behave differently and that corporate diversity rather than the loss of it has resulted in less competitive pressure on spreads however there is another problem caused by the loss of diversity in financial services and that is financial instability the demutialisations prompted or allowed by the 1986 Building Societies Act is one of several changes in regulation that changed the financial landscape another significant change was Big Bang in the UK that enabled the banks to engage in investment and retail banking under one roof and the repeal of the Glass-Steagall Act in the US these paved the way for banks that have previously been specialised in either retail commercial banking on the one hand or investment banking on the other to diversify across a range of activities the distinction between firm diversification and corporate diversity in a market is an important one especially in banking where there are spillover effects from each individual bank's risk to systemic risk a danger of the system collapsing full diversification within a firm spreads risk for that firm but if all firms move in the same direction what we end up with is replicating the same firm over and over if all firms move in the same direction this can lead to increased systemic risk for any individual firm risk is spread by diversification intuitively this is equivalent to not putting all your eggs in one basket but by supplying and by supplying a range of financial products and services firms in the financial sector are able to spread their risk but for the industry as a whole risk is spread by having different types of firm specialising in different activities one of the trends that has emerged since Big Bang and the repeal of the Glass-Steagall Act is an increase in firm diversification as banks were allowed to engage in a wider range of activities this has led to banks becoming more similar as they each diversify into the same set of activities and so we're back to replicating we've got one bank all banks now do everything and they all look the same a number of recent studies have highlighted the link between different aspects of diversity and the stability of financial systems for example Andy Haldane and May's analysis in nature analyses the sources of systemic risk in banking systems and identifies diversity across the financial sector as a key factor that promotes stability systemic stability and they do that using complex systems theory and this is what they have to say and I should say that they are very important for financial stability in the Bank of England in the run up to the crisis and in the pursuit of diversification banks balance sheets and risk management systems became increasingly homogenous for example banks became increasingly reliant on wholesale funding on the liability side of the balance sheet and managed the risks using the same value at risk models this desire for diversification was individually rational from a risk perspective to a system as a whole and more interconnections because they securitised their assets and sold them on thereby increasing systemic risk homogeneity fragility and more recently earlier this year Goodheart and Wagner came to similar conclusion the biggest institutions are now operating in the same global markets undertake the same activities and are exposed to the same funding risks this lack of diversity is very costly for society similar institutions are likely to encounter similar problems at the same time this makes a systemic crisis such as a crisis of 2007 2009 more likely and we all know what the effect of that is the banks seem to have lost sight of their main purpose and we ended up bailing them out two, I mean a phenomenal amount of money and one of the other things that Haldane has done is not just to estimate how many billions we spent bailing them out which we know but to try and estimate the total loss in GDP because financial crisis nearly always spread to the real side of the economy in the case of the last financial crisis of which we're still feeling the effects so that's really what I want to say about financial systems I want to now look at the question of innovation innovation matters because it's widely held to be an important source of prosperity however while innovation has this potential and has brought undoubted benefits we should note that not all innovations are good the financial sector introduced a new product several years ago it was called the subprime mortgage but it is wrecked havoc on our financial system and the crisis has spread as in the case of most financial crisis to the real side of the economy and we're still feeling the effects research on innovation and prosperity can be traced back to the classical economists however it's only over the last 20 years or so that innovation studies has emerged as a distinct orbit into disciplinary field research focused on the nature determinants and effects of innovation within this work it's important to distinguish innovation from invention invention is a necessary prerequisite for innovation but it's only when an invention is exploited by business and society that it starts to your economic benefits in terms of higher productivity growth and well-being early work on innovation highlighted the distinction using the linear model of innovation which postulated a flow from the research base of which universities and research institutes are apart we carry out basic research and applied research through to applied research and innovation while often cited in the literature the linear model is incomplete and it's something of a straw man the research an invention may be a necessary prerequisite for innovation innovation is neither an immediate nor an inevitable outcome of research knowledge, creation or invention in fact the time taken for knowledge discovery or invention to innovation may be decades and to appreciate this more fully an example that I like to use is the discovery of the structure of DNA as I'm sure I like this because most people know when it was discovered in the 1950s in 1953 but it's only now in this century 60 years later that we see the emergence of a biotechnology industry that can use this research and commercialize it but today that industry is still not self-financing it's being funded by venture capitalists who are anticipating large profits in financing the industry but very very few biotechnology companies are profitable the point I want to emphasize here is that basic research and knowledge creation are very different from innovation and the reason the linear model is inadequate is because it fails to recognize the institutional context the different actors involved scientists, business people, government knowledge creation is about having the time and space to think the unthinkable free from short term commercial pressures with no other purpose than the advancement of understanding and discovery it was an intellectual challenge that motivated Crick Franklin Watkins and Watson, not profit in contrast innovation is about the commercial exploitation of knowledge it has an immediacy and financial imperative and the motivating force is profit or market share knowledge creation and invention is a long term activity the commercial exploitation via innovations normally has by comparison a relatively short time horizon and knowledge creation typically takes place in the science base in universities and publicly funded research institutes and is carried out by academics and researchers much innovation occurs in industry and is implemented by business people the world of academia differs from the world of business in terms of culture language, motivation and time horizons and some see that as problematic I would argue that it's a very good thing the complexity of invention and innovation demands a specialisation of tasks we need researchers to follow their intellectual curiosity to conduct blue sky research and we need businesses to commercialise the ideas that flow from knowledge to generate wealth employment and competitive advantage and prosperity as well as to solve key problems particularly in the field of health however the different imperatives and cultures of academia and business mean that knowledge transfer and cooperation between the science base and industry requires an understanding of an acceptance of these differences knowledge transfer is not going to happen otherwise this discussion illustrates the inadequacies of the linear model the linear model suggests a smooth transition from research to development and innovation greater, actually it was a boom to the university the idea was you put money in the university and it would feed through to innovation greater expenditure on R&D will miraculously emerge at the other end as innovation in reality the gap between the science base and industry is typically long and wide more detailed reflection on the processes involved in innovation illustrates that it often requires cooperation between firms and between firms and universities within a system governed by rules and institutions this is because knowledge creation and innovation are not just separate processes they are typically carried out by different people in different organizations with different objectives thus we have a glimpse of the complexity of innovation that is glossed over in the linear model but this omission is just one of many the extent of knowledge transfer will depend on many things including the financial system the skills and education of the workforce managerial and organizational capability the system of corporate governance the legal system especially in relation to property rights and intellectual property the degree of social capital the extent and depth of university business to business interaction and cooperation and government policy measures designed to promote research technology transfer innovation and diffusion these factors combining what Christopher Freeman called systems of innovation which he said described as the network of institutions in the public and private sector whose activities and interactions initiate, import, modify and diffuse new technologies the national systems of innovation approach focuses on the central role that knowledge and innovation play in determining productivity growth and these processes are analyzed in the context of a social economic system that encompasses interactions between a range of actors including businesses and universities a characteristic of innovation systems is path dependency one of the causes of path dependency is the absorptive capacity of firms the ability to absorb ideas and knowledge from other actors this depends on the skills and education of the workforce especially science and engineering graduates firms track record in R&D investment managerial and organizational capabilities and firms expenditure on training the systems of innovation approach has begun to enhance our understanding of the ways in which advances in knowledge, skills and technology are translated into improved business and economic performance however while national and global factors are important there is now a growing body of research that points to the importance of regional factors that determine innovation and these include the degree of individual and organizational learning within regional systems of innovation central to this literature is the role played by knowledge knowledge is a crucial input into the innovation process yet is an input that is difficult to define because it contains both explicit and tacit elements explicit or codified knowledge is knowledge that can be encapsulated in formats such as language, text blueprints, operating manuals codes or guidelines and transfer to users who are able to interpret it and utilize it independently from the context in which it was created in contrast tacit knowledge cannot be codified in this way and it can't be easily transferred transfer of codified knowledge is not strongly dependent on geography as codified knowledge can travel but tacit knowledge on the other hand does not travel well and as a result we observe a strong geographic concentration of research and development expenditure moreover we find that there's a positive I mean you can think of classic examples of silicon valley and the Cambridge phenomenon moreover we find that there's a positive association between regional prosperity and regional knowledge and innovation performance and this slide shows the large gap in income per capita across regions which in part reflects differences in innovation performance across regions and the reason I put this graph up is the different coloured bars show different years from 2000 to 2009 and there isn't any change in the ranking of the regions London is a lot richer now than any other region so is the south east the order of the regions there hasn't been convergence and catch up which is a prediction from convention analysis and part of the explanation of this London is an exception because of public expenditure on R&D which is not shown on these figures and because it's of its service sector base but part of the explanation for the regional differences in prosperity differences in innovation performance and that's reflected in one measure here and in one measure only there are others that matter is R&D expenditure as a percentage of gross value added in the UK R&D expenditure is very heavily concentrating one sector pharmaceuticals which accounts for almost 40% of the total R&D expenditure in the UK however this does not explain all of the variation other systemic factors are at play the concept of a system of innovation has been applied at the regional level because knowledge flows between firms research organisations institutions and public agencies are cheaper and easier when firms operating close proximity the extent and speed of knowledge transfer tacit knowledge transfer between different organisation reflects the ability of local and regional economies to learn and absorb knowledge and since proximity facilitates the transfer of tacit knowledge innovation activity takes on a strong regional dimension that may be reinforced by other economies, agglomeration economies in the production and in production and pools of skilled labour and human capital the ability of regional economies to generate, assimilate and transform knowledge reflects the learning capability of a region the learning region may be seen representing the territorial and institutional embeddedness of learning organisations and interactive learning within this the innovative capacity of the regional firm is related to the learning potential of the region or ability of the region the ability of a region or a firm to learn is also shaped by its absorptive capacity which can be defined as the ability of a firm or region to assimilate and utilise knowledge absorptive capacity depends on the internal capabilities of a firm and region and the existing state of knowledge in that region thus absorptive capacity results in cumulative causation in learning and innovation in this lecture is interesting because it is a public lecture and some people some of you will have knowledge of economics and some of you won't probably what I say will have more resonance with those of you who have some knowledge of economics because inevitably there's a language and a structure and so on to these arguments that you'll be familiar with that this lecture will key into and that's really the idea of absorptive capacity the downside of absorptive capacity is that regions that lag behind in income skills and investment in knowledge and R&D find it harder to absorb knowledge and to innovate something which my colleagues Kevin Morgan and Mikael Lander-Bassani called the regional innovation paradox and the paradox is that the regions that need to invest most or innovate most and invest most in innovation in order to catch up and improve their performance are the least able to absorb funds for innovation even when they're offered as public subsidy a similar paradox exists for individual firms those firms that need to invest most in innovation in order to compensate for the lack of past innovation lack the necessary skills particularly human capital and a track record of winning R&D to make the necessary investments in R&D to absorb knowledge from other firms and from universities the problem of low absorptive capacity explains why financial incentives alone for R&D will not help firms and regions that should make the most use of them will find it the most difficult to do so because of a lack of capabilities including organisational and managerial capabilities and low absorptive capacity and I'll turn now to the third case environmental sustainability and the interaction between ecological systems and economic systems the conventional approach to studying things like environmental pollution is to see them as a negative externality a by-product of economic activity not captured in the cost of production or the price of products so for example companies may emit CO2 gases pollute rivers or over fish and these activities damage our environment because producers do not pay for the damage and because in some cases it is very hard to assess the damage it may pop up on the other side of the globe and affect countries and populations that are far away markets are said to fail however some economists William Cap and Richard Nelson see externalities not as the exception but as the norm as the general case that is inherent in any economic system and they refer them instead as social costs externalities are not a special case they are the norm and they arise because there is often a conflict between individual incentives and collective outcomes and in other words one of the hallmarks of a complex system and I think this quotation from Hardin who has done a lot of work on the tragedy of the commons is very insightful because it shows that Adam Smith's invisible hand can have very negative effects that same principle with Adam Smith's work as a model I had assumed that the sum of separate ego serving decisions would be the best possible one for the population as a whole but presently I discovered that I agreed much more with William Foster Lloyd's conclusions as given in his lectures of 1833 citing what happened to pasture lands left open to many herds of cattle Lloyd pointed out that with a resource available to all the greediest herdsmen would gain for a while but mutual ruin was just around the corner as demand grew in step with population while supply remained fixed a time would come when the herdsmen acting as Smithian individuals would be trapped by their own competitive impulses the unmanaged commons would be ruined by overgrazing competitive individualism would be helpless to prevent the social disaster examples of the commons include fish stocks, clean waterways and the atmosphere clean air individuals have a private incentive to exploit the commons but if all of us act in this way there's a real danger of the depletion of fish, the depletion of rivers and of atmospheric damage and climate change common pool resources such as fish stocks, clean rivers and waterways and clean air would need to be managed if there to be protected society can and does find ways of regulating the commons with differing degrees of success market incentives can play a role in this taxes and subsidies but if we were to meet the greed targets on carbon emissions we either need to grow less or to raise carbon productivity significantly one estimate by Bayne Hawker that we will need a tenfold increase in carbon productivity by 2050 three times the rate of labour productivity achieved during the industrial revolution complex system analysis has been used to look at the interaction between socio-economic systems and natural or ecological systems and this was a topic of an ESRC research seminar that I was part of with my colleagues Terry Barker, Tim Foxon Jonathan Kohler and Jonathan Mickey as we've seen with the QWERTY keyboard it's difficult for new technologies to break into the market and so it is with green technologies for the automotive industry and one of the papers I wrote with Jonathan Kohler and Jonathan Mickey and Lorraine Whitmarsh was called Can I quite like the title of this Can the car maker save the planet and the answer we reached was well not by themselves but by a petrol engine technology that requires collective action in order for us to escape and the sources of the lock-in are two-fold one is economies of scale in carbon reduction that means you need to have a big market in order to produce at a competitive price and the other one is network externalities in petrol supply stations there are alternative technologies such as hybrid vehicles but in order for these technologies to break through market demand for these models has to be sufficient to allow them to reach the same economies of scale enjoyed by conventional petrol engines the regulations imposed by the state of California were very interesting an environmentally friendly state an environmentally unfriendly country did make a sufficiently big difference or big market for the hybrid technology to break through which is why we do have hybrid vehicles though they are still more expensive however electric vehicles purely electric vehicles face a second hurdle that is infrastructure based our system has a well established network of petrol stations but not a well established network of recharging points for electric cars and this makes it very difficult for electric engines to become established in the marketplace if we were to meet these environmental challenges we need to work on the interface between social science and science and as Cap has noted we need to explore the interaction of several complex systems economic, physical, meteorological, biological in which a polarity of factors interplay through feedback processes an interaction which is much more complex and much less explored and understood in the functioning of the various systems which the conventional social disciplines have ever studied Professor Sir David King chief scientific advisor to the UK government from 2000 to 2007 gave the closing address very kindly at our ESRC research seminar complexity economics for sustainability but he laid down the gauntlet for solving environmental problems to the social sciences arguing that there are scientific solutions and the problem was not the scientists it was a social scientist and the social economic and political system and that we needed to get our house in order in order to prevent environmental damage and promote sustainability I hope that I provided some insight tonight into how thinking about complexity and diversity may provide a way to help us meet this challenge but there I must stop Thank you for coming tonight and thank you for listening so patiently Let me say that I'm a honour to be here to express the vote of thanks for Christine I will be very short because it's late but I want to give you a couple of schnaps of the life of Christine the first is just a digression I think there is a cross cutting issue in the life of Christine which is her love for Italy and this explains why I am here I don't know that this was a choice but Christine was the only British PhD student in economics in Cambridge and she was absolutely surrounded by Italians she started loving pasta and cakes we were cooking she started understanding the Italian way of speaking we moved the hands of expressing she started coming to Italy learning Italian she first went to the European University Institute as Lauren said then she went to many trips to Italy to work for fun and then she ended up even in Bolzano as a professor now to be honest with you now she has a rusty Italian because in Bolzano they speak German they don't speak Italian let me go back to the old days in Cambridge in the early 80s when I first met Christine she just disclosed this information 30 years of friendship that's a long time we were in Wilson College a graduate college on the outskirt of Cambridge and we had pasta and ice cream or coffee but endless discussion on Keynesian versus monetarism on the probability of unintended negative consequences of what later was called the Washington Consensus on the importance of understanding the structure of the economy on the importance to find the appropriate policies we were a big group with a variable geometry sometimes 2 of us sometimes 15 out of them about 10-12 were always Italians it was a very multidisciplinary crowd some participant to our discussion were in different field but we were sharing everything and especially the enthusiasm for debating I never found in my life such a lively group and I believe that Christine work and today lecture especially are deeply rooted in those discussion the second schnapps that take us around UK and I think Lawrence gave a very good picture of Christine she was in University of East Anglia then up north in Glasgow then in Birmingham then in London Berber College and as Lawrence said she became a really football star not really playing but discussing about football she studied the governance the regulation of football and she started being invited to speak in all the major conferences on sport on regulatory issues and rather than seeing her and discussing with her I would see her in TV at that time but now this is the most important one she arrived at Soas and as I said to her before it's the only place which convince her to leave Italy I think this is a very important for Soas and is here recently that her work has had a really big push maybe the environment was the right one maybe she started again the discussion of our first exciting years you just heard and I would reiterate what she's speaking what she's working on she wrote a great paper a path breaking paper as we heard from Lawrence on regional innovation paradox this was published in 2011 and is highly cited just for fun I look at this age citation index which is so trendy now amongst economists well it almost doubled the one of Christine after this paper now Christine points out the existence of regional innovation paradox lagging regions that need to innovate she said are actually the ones that find it more harder than leading regions to absorb funds for innovation and this happens even when the funder offers a public subsidy and this is due to the dependence and lack of regional capabilities the regional innovation paradox shows us that there is cumulative causation a la caldo that non-economists will not understand because we speak about caldo Christine proposes to use a system approach and she convinces us where we should go beyond the obsolete linear model which is too simple to allow to account for the complexity of the world the paper on regional innovation offers many insight in terms of showing regions the importance of building regional competitive advantage starting from existing capability and extending these capabilities if, as I think Christine does we aim at bridging the gap between academic work and policy implementation certainly her paper is key and is relevant and especially doable policy implication this is not all you have heard that just in the last year or so Christine has started working with co-authors using insight from complex system theory she emphasized the distinction between simple and complex system that arise when individual action produce outcome in the aggregate which are unintended an obvious example that she gave without really mentioning it is the Keynesian contradiction between the micro and micro behavior when firms, she mentioned this firms cut output in the recession thereby deepening the recession itself she also discussed the mix oligopoly model with different type of firms arguing that the standard approach between public private needs to be extended to consider more nuanced set of private organization and this is the diversity that she has been mentioning all day today her analysis however open up to a new regulatory toolbox for policy maker regulation from within encouraging diversity promotes competition she said but can also promote financial stability so basically it kills two birds with one stone competition and financial stability now Christine also applied complexity to understand environmental problems highlighting the importance of the interaction between the economic system and the ecological system she points to the fact that for instance not all firms will respond in the same way to a tax on carbon some of them will innovate some of them will cut production and I think the example she gave about the California beside the fact that Christine has an hybrid car herself is fairly interesting about that she highlighted the complexity economics illuminates why we get locked in into inefficient technology with a quality, with a carbon tax and so on and so forth and this is the first step to understanding how to make the transition to the new, more efficient and more environmental friendly technology what we should follow, what's next now let me conclude just by saying that we are at saw us and I think what Christine has studied so far with complexity should be also applied to developing countries I suggest a topic for paper for next paper, maybe even a joint paper since I'm studying development do poor country have to go through the same technology path we followed or could I go straight to greener and cheaper technology I think this will be good to work on that and what I say now is just thanks to Christine and let's have a toast with her upstairs where we go for a drink