Second Part

0:09:07 The things that supervisions can do that other kinds of education can't is to draw out creativity and originality by asking difficult questions; I believe in not telling them too much about what they should read; I only supervised undergraduates for five years; on lecturing, I enjoy the business of working out the subject and putting it together, yet I have never felt I could actually write a textbook despite having reams of notes; I might have been one of the earlier ones to like to provide notes to circulate to the class rather than have them scribble their account of what you said; that was not something that the maths lecturers that I'd had in Cambridge did; I also lectured on development; that was where I felt there was more scope for creativity, trying to think out what development economics was; I only did it for two years; I must have made most of it up out of my head, I certainly did not have a text book to follow, so my notes actually got into the Marshall Library; I would be curious to know whether they are still there; I was delighted when some years later it was reported to me that someone who then worked in developing countries thought that it had been the best course on development economics, and that he had been well prepared

4:20:20 Amartya Sen became a friend, indeed it was he who introduced me into the Apostles; I learned a lot from him, particularly reading his thesis and then his books; I worked through his book on social choice and the notes on it; I think my first publication was a review of the book that contained Amartya's PhD thesis; somehow that rather cemented our friendship; his range is great, but I am not entirely sure that social choice is a good topic to spend a lot of effort on though he has certainly done some very good things with it; in some ways some of the most intellectually admirable things in economics have been in social choice; I keep coming back to it; the closest I have got to it is a paper and a chapter on utilitarianism from the point of view of an economist, in a book that Bernard Williams and Amartya edited; Partha Dasgupta was my student; he did the one year diploma course and then I brought him into the same kind of problem that I did my thesis on, optimal saving, adding optimal population as well which James Meade had done very good things on; I don't know if that was how Partha met his wife, one of James's daughters, but they might have made contact that way

7:33:06 I married in 1961 before going to India; my wife was a teacher and had graduated from Homerton the previous year; she came with me to India which was harder for her than for me; we went via America because it was an MIT project, and there we were handed a piece of paper on culture shock to prepare us; we were amused by the instruction that if bitten by a dog, keep it there until the police arrive so that it can be tested for rabies; when it came to the point I don't think that culture shock is the right description for being in a very different country without an occupation; after the first six months it was OK; we had two daughters who have each produced two children, so we are proceeding in the appropriate steady state manner; she died of breast cancer in 1993, which was very sad; it would have been nice if she had lived to see me get the Noble Prize in 1996, but at least the girls were there; I have remarried since

11:09:10 Now head of a new college, Morningside College, at the Chinese University of Hong Kong, which will not exist until 1st August 2009 and will not take its first students until September 2010; for me it is important as in some ways I feel it is taking too long; it is not that I feel too old but it is not quite so easy to relate to students; heads of colleges in Cambridge are not necessarily much in contact with students, certainly in the past they were not; the President, Professor Lawrence J. Lau, had suggested that the college should be as much like a Cambridge college as possible; he had spent a year as a visiting fellow at Churchill and had been rather impressed; but being as much like as possible is still a long way from being like a Cambridge college because we don't have any real teaching fellows, although we will expect fellows to do a little teaching; the amount of teaching that we will do as a college will be little, particularly against the Hong Kong background where the examination questions tend to be pretty routine and rote like, and the students seem to want to know exactly what is expected of them; what I particularly valued about my Cambridge education and also what I thought I could achieve with graduate students, particularly later in Oxford, was drawing out originality from students that so many of them seemed to have already; at the college level that means getting people into the right sphere or subject; I am intrigued to know just how much we can do in order to achieve this; at the moment I am slightly fearful that there may be some conflict between what I would like to do as a college and what the university thinks colleges should do; they are increasingly saying that what they want the colleges to do is personal rather than academic development; I shall have a little bit of a task to make sure that we lean in the direction of creativity and independent thought; we expect to get a lot of people from mainland China, probably 30-40% of the student body in the College

16:26:18 I am not worried about what will happen in mainland China although we know the kinds of things that can happen; certainly I would like to see a move towards what I would think of as real democracy, but there is quite a way to go; there are independent lawyers and a great range of opinion; when I am in mainland China there is no serious restraint in conversation, so it would be wrong to say that there is not an openness in society already; we are not talking of a thoroughly authoritarian regime; it is interesting to see the way that it has gone, which has something to do with economic freedom but it is not only that; for an economist it is particularly interesting when you see universities where you see essentially two departments of economics, one of which will be quite Marxist and the other is called 'Western Economics'; the fact that they are both there is clear evidence of an openness in the society which people outside don't seem entirely aware of; one gets disturbed by such things as taking over property, but then reflects that that is not unheard of in Britain and America; a lot of the things that are referred to as problems are actually quite similar to things that happen in the West; recent troubles in Xinjiang are analogous with riots in Los Angeles or the Troubles in Northern Ireland; all this suggests that it has come a long way and there are grounds for general political optimism, although I would be surprised if there is anything analogous to the Soviet Union breakdown as they do seem to have a rather well-organized system; the Communist Party is exceptionally well-organized but with one proviso, certainly the Chinese Government sees a lot of corruption, and you don't expect corruption and good organization to go together; I dare say that there are more serious problems in some areas than others, and with that you are never quite sure which way it will go

20:50:16 On work that led to receiving a Nobel Prize: I got there by thinking about taxation; suppose you thought it a good idea to equalize incomes, and that you could do that by levying taxes at a very high rate, it is obvious to nearly everybody that this is not likely to work very well; the threat of doing that would create a pretty unsatisfactory economy; but I think it is important to find a rigorous formulation of that; part of what I was engaged on, working with Peter Diamond at MIT, was to give a fully rigorous account of the workings of the economy when you pay attention to the problem of incentives; the question is, what is the problem with incentives; I can see great economists like Paul Samuelson clearly understood what that is in some of their writings, but it seemed to me that most people did not; here is another of those areas where a number of us got onto the point simultaneously, saying that another way of looking at this is that it is all about information that people have about other people, and recognising that a lot of our economic relations with people are not like buying and selling in the local market but more like having a contract with them; on the recent financial global crisis, I think that one of the things we should have learned from all this might have prevented it; once you see the limitations that people have about one another this means that when you write a contract, for example, to get someone to deliver something to you in a couple of years time, and maybe you pay him now for it, it is not that you are not quite sure that you can trust him to do it, but you can't be sure that he is going to be able to do it; an absolutely key example of this is in relation to the government and the taxpayer; the government would like to levy a particular tax; the ideal tax is one where you tax people on the basis of their earning abilities; it would not be an entirely bad idea to base tax on examination results, but you would straight away run into the problem that if you do try to institute that idea then people will start getting very poor exam results; it is just the same sort of thing as the very form of the relationship, in this case the social contract between the government and individuals as described by the tax system, that this creates incentive problems; in deciding what the tax system should be we have to choose that, subject to the constraint that you have limited information about people's actual abilities; all you know about them is what they will do, you don't know what they can do; once you see this as being a central economic relationship, you realize it is not like buying and selling, so there is a whole area of economic activity which is missed from the standard basic model; I wrote down a particular model of this kind which I called an optimum income tax problem; it was intended to be a good description, as simple as possible, of an economy in which incentive problems mattered; of course it was mathematical because that's the way I do things, and then I found there was a really difficult problem of even finding equations which would describe the optimum; that was the problem I cracked and that was what I was really pleased about, that I found the answer to a partly conceptual, partly mathematical, problem; partly conceptual because it is a matter of expressing these general ideas in a form you can work with mathematically

27:27:18 It must have been a eureka moment but oddly enough I can't locate it in time; I think it must have been close to the end of my time in Cambridge; on the current financial crisis, in my view one of the major reasons we have suffered this is because there was a market for a particular kind of securities; people were buying and selling these famous CDOs, bundled mortgages, as though they were oranges and apples; so a market was established and priced; that meant that you didn't have a contractual relationship; it meant that nobody had taken the chance of creating the right kind of incentives for the lenders, for the bankers; as a result the banks were lending too much and they were lending carelessly; it didn't matter to them whether somebody was going to pay back or not because they were being sold on; twenty, thirty years earlier economists, of whom I was one, had developed a theory of these kinds of things and made it quite clear that you shouldn't have a market for securities of that kind; I suppose the economists who had worked that out didn't know what kind of securities were being traded; perhaps, like me, they were the sort of economists who were not much interested in self investments, that keep their money in savings accounts; there were some very good theories, such as moral hazard; the insurance industry had been well aware of moral hazard for a while but they don't seem to have been very good at understanding it; moral hazard is when there are things you might do which cannot be observed, where people cannot deduce what you did either, because the results of what you do were pretty uncertain; you might have some unobservable action; you don't know the sort of people that a bank has decided to lend a lot of money to, and you certainly don't know how carefully a lender considered the risks that were involved and what kind of information he got; moral hazard is a curious term as it does not get people to focus in and see just what it is that is going wrong; we need a term that describes the behaviour; the problem is when you have behaviour that you can only imperfectly deduce from the outcomes; therefore you have to write a suitable contract on these outcomes that will create the right kinds of incentives to behave appropriately; behaving appropriately isn't necessarily what you would do if you could be authoritative and tell someone what to do; you have to be moderate in the use of incentives; generally you get the right incentives if people have to bear some of the risk of their actions themselves; if you go to complete insurance which is what had effectively happened in the financial system then you get bad results

33:55:24 I haven't been looking at things in sufficient detail, just looking at newspapers and seeing what the central bankers are reported as saying; it does not seem to me that they are showing the right kind of understanding; they don't seem to have said that this is how we are going to ensure the moral hazard problem is solved, indeed they talk as though banks should be pretty much left to carry on as they were with people just observing more carefully; what they don't understand is that observing more carefully is not the answer; you have to pay attention to the incentives that the banks have to do their business, just as the banks should be paying attention to the incentives that the borrower has to pay back; the really important one is all these silly derivatives that have been created giving great financial reward to the individuals who create them with negative social value; lots of people should have seen what would happen as it had happened before

36:39:22 Something I value is the students that have passed through my ministrations, particularly graduate students; three of my students were professors in Cambridge, one in Oxford, several at LSE and at MIT, and so on; I am not saying that I should get a vast amount of credit for this, but they have done great research and sometimes have performed very well in other spheres and that has given me a lot of vicarious pleasure.