Crawl Across the Ocean

Monday, June 29, 2009

Quote of the Day for June 29, 2009

"The Information Age is over, and most of the information was bad news."

from CK.

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Thursday, June 25, 2009

That's Going to Leave a Mark

Perhaps irritated by being likened to Idi Amin and described as a "'little professor in glasses' leading 'a bunch of wacked-out muppets'," Larry Lessig lowers the boom on Mark Helprin's new book "Digital Barbarism."

It's hard to imagine a more comprehensive demolition - it's sort of like a more polite, yet still almost as humourous, version of one of Matt Taibbi's famed essays mocking Tom Friedman.

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17. Trust: The Social Virtues and the Creation of Prosperity

Note: This post is the seventeenth in a series. Click here for the full listing of the series.

The point of Mancur Olson's 'Logic of Collective Action' was that a group of people - especially a large one - will struggle to work together unless their collaboration produces specific benefits to the group members as opposed to public benefits that will accrue to all group members regardless of what effort they put in.

So I thought that a logical follow-up would be to look at groups where there *is* a specific benefit to group members. Now I could be talking about religion here (where the reward for good religious behaviour is some sort of post death reward/punishment that is specific to each member of the religion) but I'll leave that aside for now and talk instead about companies.

In the Efficient Society, Joseph Heath opened his chapter on big business with a personal anecdote about Quebec's annual St. Jean Baptiste Parade:

"The year I attended, one of the major components of the parade was a series of floats celebrating the 'giants of industry.' All the big corporations in Quebec - Bombardier, Hydro-Quebec, Quebecor - were represented.

The suggestion that people should take pride in the fact that their economy is dominated by large corporations in one that would be quite foreign to most Canadians outside Quebec...

In part, this is because people outside of Quebec take the existence of giant corporations for granted. In Quebec, however, where society has only recently emerged from a long period of relative economic backwardness, these corporations are the symbol of a modern economy. The only way to be a real player on the world stage is to have some big companies that can compete in the major leagues. Thus there is a natural harmony of interest between Quebec nationalists and the various and sundry home-grown tycoons."

Here's a personal anecdote on corporations. A few years back now, I was on a class trip to Mexico and we visited a relatively high tech plastics factory in Guadalajara. The company, which at the time employed hundreds, had been built up from scratch by the founder over the course of a few decades but now that he was getting older, he was trying to decide who should take over the company.

His preferred option was to pass the reins to one of his children, but none of them were interested. The next best option seemed to be to pass it over to his partner of many years, however this was not optimal because, although his partner was willing, and had the skills necessary, and had been a good friend of the founder for decades, he wasn't family.

It was a bit like watching a scene from the Godfather. What was not considered, even as a remote option, was taking the company public and allowing it to be run by professional managers with no personal relationship to the owner and founder.

Given the size of the country and economy, Mexico has one of the world's most undeveloped stock exchanges with less than 200 hundred companies on it, most of which are either former crown corporations or foreign branch operations (e.g. Wal-Mart Mexico).

* * *

OK, enough anecdotes, let's get to the book that is the subject of this post, Francis Fukuyama's, 'Trust: The Social Virtues and the Creation of Prosperity"

The short version of the book is that in cultures where there is a high degree of trust of strangers, there is a greater likelihood of large, professionally managed corporations being created and greater prosperity as a result.

In more detail, 'Trust' contains two interwoven storylines. The first storyline is a relatively empirical and concrete survey of a number of countries which range from those with a high degree of trust and sociability (The United States, Japan, Germany are the focus, with the other Protestant, Central European countries (Holland, Denmark, Sweden, etc.) also placed in this category) to those with a lower degree of trust and sociability (China, Italy, France and Korea are the focus, with Canada, New Zealand and Latin America considered further examples) to those where trust has broken down almost entirely (there is less focus on this group, with some discussion of the South of Italy, and with American inner cities and Russia being other examples).

Starting at the bottom, in areas of very low trust, organizations beyond the state and the family are weak, nonexistent or criminal (mafia, gangs), and even the state and the family are often weak and/or corrupt.

The middle group is one where trust and social virtue is strong enough that the family (often including the extended family) and the state are capable of sustaining economic organization, but the growth of large, successful, professionally managed corporations is rare. Fukuyama notes that these cultures are often just as wealthy, or nearly so, as the high trust cultures that can generate large corporations. He also notes that in cultures such as this where the level of social trust is too low to sustain corporations without assistance, the state can often play a helpful role by stepping into the breach.

Let's go back to the Heath quote above and review the three large Quebec corporations he mentioned: Hydro-Quebec, Quebecor and Bombardier.

Hydro-Quebec is, of course, a fully state create, owned and managed monopoly.

The first line of the Quebecor wikipedia page reads as follows, "Quebecor Inc. is a communications company based in Montreal, Quebec, Canada. It was founded by Pierre Péladeau, and remains run by his family.

Finally, Bomardier. Here are some quotes from an article about the departure of Paul Tellier from the CEO position,
"WHEN PAUL TELLIER took over the reins of BOMBARDIER INC. in January 2003, it appeared the family-controlled aerospace and rail giant was finally going to allow an independent boss to call the shots. Wrong.


The reason for Tellier's departure given by Laurent Beaudoin - son-in-law of the company's founder, Bombardier's executive chairman and now the lead player in a newly created three-person Office of the President - was that Tellier hadn't planned on continuing with the company after his three-year term as CEO was over at the end of 2005.


Whatever the cause for Tellier's departure, the result is indisputable: the family is back, firmly in charge. And perhaps, observers suggest, that's what was really at issue. In the new president's office with Beaudoin is his son, Pierre, who many think is being groomed to take over. Two independent directors followed Tellier out the door; with the promotion of Beaudoin's son to the board, that leaves the family holding five of the 13 seats, compared to four of 14 before the recent events. Last year, Tellier tried, without success, to revamp the company's ownership, replacing the dual-class share structure that guaranteed family control with a one-share-one-vote system. The existing formula allows the family, which owns 16 per cent of the equity, or less than one-fifth of the business, to call the shots. Which it just did, by showing Tellier the exit."

After the low trust but still functional societies, Fukuyama looks at the high trust cultures. In each of Germany, Japan and the United States he points to unique historical factors that supported the development of trust beyond just the family level (for example, strong, relatively small religious groups in the U.S. such as the Mormons).

If you try coming up with brand names in your head, odds are whatever comes to mind will either be a Japanese, American or German (or Dutch/Swedish/North-Central European) company that you think of. And if there are exceptions that come from other countries, many of them will be state founded or supported companies.


The second, more intriguing thread in the book, is a theoretical contrast between individualism and communalism.

Much of the first few chapters are taken up with Fukuyama's repeated assertions that the neoclassical economic model of people as rational self-interested utility maximizers is not 100% accurate. For example:

"it is very questionable whether human beings act as individual utility maximizers rather than seeing themselves as part of larger social groups"

"while contract and self-interest are important sources of association, the most effective organizations are based on communities of shared ethical values"

Nonetheless, it appears as though he fears being considered 'not serious' if he doesn't mostly accept the rational self-interest theory and he hastens to note that,
"The edifice of free market economics is .. about eighty percent right, which is not bad for a social science and substantially better than its rivals as the basis for public policy"

Still, he points out that even this 80% view puts him in opposition with many economists who take after Margaret Thatcher's notion that 'there is no such thing as society' and believe that there is one set of free market economic rules that will work best for every country and every culture.

In chapter 5, 'The social virtues', Fukuyama sets out to define just what virtues we are talking about here when he refers to trust and sociability. He notes that the virtues which make up Max Weber's well known 'Protestant work ethic' are mainly individual in nature, but there are also social virtues as well.

"The capacity for hard work, frugality, rationality, innovativeness, and openness to risk are all entrepreneurial virtues that apply to individuals and could be exercised by Robinson Crusoe on his proverbial desert island. But there is also a set of social virtues, like honesty, reliability, cooperativeness and a sense of duty to others, that are essentially social in nature. (p46)"

He further notes that, "spontaneous sociability is critical to economic life because virtually all economic activity is carried out by groups rather than by individuals. (p47)"

Later on, in his discussion of France, Fukuyama touches on some of the cultural characteristics that don't support economic growth:

"Jesse Pitts ... argued that the successful French bourgeoisie was co-opted by the mores and values of the aristocracy. The latter held capitalism in low esteem and prized the noble, individualistic act of prouesse, or prowess over the process of steady, unremitting rational accumulation. The French bourgeois family did not seek to overturn the status quo through growth and innovation, but rather aspired to the settled, landed, rentier status of the aristocracy (p116)"


"The solidarity of the traditional French bourgeois family, with its tendency to look inward and its concern for its status and traditions, has been a staple of French literature and social commentary"

* * *

On page 154, there is an interesting quote from Nathan Rosenberg and L. E. Birdzell on how, as Europe moved out of feudalism, a need developed for a separate set of morals for trade,

"The need for a form of enterprise which could command trust and loyalty on some basis other than kinship was only one facet of a broader need: the rising world of trade needed a moral system. It needed a morality to support reliance on its complex apparatus of representation and promise, credit, representations as to quality, promise to deliver goods, or to buy goods in the future, and agreements to share in the proceeds of voyages.

A moral system was also needed ... to supply the personal loyalties necessary to the development of firms outside the family, as well as to justify reliance on the discretion of agents, ranging from ships' captains to the managers of remote trading posts and including merchant' own partners. The ethical system of feudal society had been built around the same military hierarchy as the rest of feudalism, and it did not meet the needs of merchants. It was out of the turbulence of the Protestant Reformation that there developed a morality of patterns of religious belief compatible the needs and values of capitalism."

It's worth noting the conflict between the desire for "a form of enterprise which could command trust and loyalty on some basis other than kinship" and the desire to move past the "same military hierarchy as the rest of feudalism" - worth noting because the corporations that filled the bill for non-family enterprise all adopted a military style hierarchy.

On the next page, Fukuyama launches into a discussion, pace Olson, of how free rider problems can mean that a society "manifesting a high degree of communal solidarity and shared moral values should be more economically efficient than their more individualistic counterparts"

It's interesting that even though Olson limited his discussion to organizations producing public goods and Fukuyama is discussing corporations that provide specific rewards to workers (i.e. they pay you to work for them) he still sees the same need for a moral code to support communal activity in corporations that Olson saw for non-economic groups that only offer public goods.

He notes that,
"if [workers] strongly identified their own well-being with that of the group, or even put the group's interests ahead, then they would be much less likely to shirk work or responsibilities. This is why family businesses are a natural form of economic organization"

He then points to the limitations of the economic notion of 'allocative efficiency' which fails to differentiate between positive and negative groups,
"...not all groups serve economic ends. Many groups are engaged in redistribution rather than the production of wealth, from the Mafia and the Blackstone Rangers to the United Jewish Appeal and the Catholic Chruch. Their purposes range from sinister to divine, but from an economist's point of view, all of them lead to 'allocative inefficiencies', that is, a mismatching of resources to their most productive uses."

* * *

Starting on page 199, Fukuyama starts to take a more abstract look at the nature of the corporation,
"While capitalism is supposed to be based on free markets and competition, life inside a Western corporation is at once hierarchical and cooperative. As anyone who was worked in one knows, corporations are the last bastion of authoritarianism: the single CEO at the top has, with the leave of the board of directors, more or less total freedom to order his organization around like an army. At the same time, the people working within the hierarchy are supposed to cooperate, and not compete against one another."

This is a strange passage. First of all, corporations are hardly the only remaining hierarchical structure and it's not exactly authoritarian when you are free to leave whenever you want. But more importantly, as far as I'm aware, people are *always* expected to cooperate in a hierarchy - this is not some unique feature of a corporation. Union members within a local are expected to cooperate, soldiers within a unit are expected to cooperate, etc. The manager in a hierarchy is not in competition with his workers, nor is he a referee adjudicating between competitive rivals. The manager is a coach who ensures that his players are playing for the good of the team and working towards the same objective he is.

Fukuyama then moves on to correctly note that the real puzzle here is that if the market is the most efficient way to arrange production, why do corporations exists and why are they so successful. Fukuyama follows the conventional thinking that this is due to Coasian transaction costs, a theory which suggests that many economic endeavours are more efficient when conducted cooperatively in a high trust environment (within a corporation) than when they are organized through interactions between self-interested market players. (more on this theory another time, perhaps, although I covered some aspects of it already, here.

* * *

Later on, Fukuyama comments on some similarities between Japan and Germany,
"The number of similarities between German and Japanese culture, many of which can be traced to the highly developed sense of communal solidarity shared by both, are intriguing, and have been remarked upon by numerous observers. Both countries have reputations for orderliness and discipline, reflected in clean public places and tidy private homes. These are societies whose members enjoy playing by the rules, thereby reinforcing a sense of belonging to a distinct cultural group. ... On the other hand, their communal solidarity within the national community weakens their regard for people who stand outside it; neither country has been known for its friendliness to foreigners, and both became notorious for their brutality to the peoples they conquered and ruled. (p 210)"

He picks up the same thread a few chapters later,
"In the past, both Germany and Japan have been known for authoritarian government and for having sharply hierarchical societies ... And yet, as we have seen, the German and Japanese factory floors are much more egalitarian than their English, French or American counterparts. ... The answer is related to the fact that the egalitarianism in communally oriented societies is often restricted to the homogeneous cultural groups that tend to comprise them and does not extend to other human beings even if they share their society's dominant cultural beliefs. Moral communities have distinct insiders and outsiders; insiders are treated with a respect and equality that is not expected to outsiders. Indeed, there is an inverse proportion between the solidarity of those inside the community and the hostility, indifference or intolerance shown to those on the outside."

I think that Fukuyama's observation about the exclusiveness of groups with strong moral bonds is accurate, but I'm not sure it explains the contradiction between a hierarchical society and an egalitarian workplace that he begins the quote with. After all, the hierarchical, obedient, rule following German or Japanese society is made up exclusively of Japanese or Germans, just as their egalitarian workplaces are.

Later on page 292, Fukuyama makes the point that, aside from being groups within the state, rather than states themselves, many religious groups in the U.S. have a similar strong cohesion within the group, hostility to those outside the group dynamic that Japan and Germany have - with the Mormons being a particularly strong example.

* * *

When Fukuyama starts to discuss the history of trust and sociability in the U.S., he launches into a comparison of an individualistic, Western, rights-based set of morals which can be traced back to monotheism, with a communal, Eastern, duty-based set of morals which is linked to Confucianism.

"The United States has undergone a "rights revolution" in the second half of the twentieth century. This revolution has produced a moral and political basis for the promotion of individualistic behaviour, with the consequent weakening of many earlier tendencies toward group life. ...

In contrast, an Asian ethical system like Confucianism sets forth its moral imperatives as duties rather than rights. That is, an individual is born into the world with a series of obligations to other people: parents, brothers, government officials, the emperor. Being a moral person, or achieving the status of a gentleman-scholar, depends on the extent to which one is able to carry out those duties. Those duties are not derived from prior ethical principles. In this respect, Confucianism is not different from much of the Western philosophical and religious tradition up to the early modern period. Many of the virtues defined in classical political philosophy, such as courage, honour, benevolence or citizenship, were duties. And God's law for both Judaism and Christianity was almost always enjoined in the form of duties.

Western political thought takes a sharply different turn, however, in the writings of Thomas Hobbes ... for Hobbes, man is not born with duties but with rights alone ... Whatever duties to takes on, he acquires as a result of his voluntary entry into civil society. Duties, for Hobbes, are entirely derivative of rights and are undertaken only to secure individual rights. Thus, one has an obligation not to do violence to another human being only because to do so would return one to the state of nature, in which one's own right to life would be jeopardized."


"Man in the state of nature for early moden Anglo-Saxon liberal political theorists was the exact counterpart of the economic man of classical economic liberalism. Both were portrayed as isolated individuals, seeking to protect their own basic rights (in the case of political liberalism) or their private "utility" (in the case of economic liberalism)."

To be honest, it wasn't entirely clear what this digression about rights and duties had to do with the rest of the book, but I found it interesting nonetheless.

* * *

Fukuyama finishes up by reiterating his argument that social capital (high levels of trust and sociability) is a driver of both political stability and economic success and then foolishly, in my opinion, trying to make a case that,
"in practice, liberal democracy works because the struggle for recognition that formerly had been carried out on a military, religious or nationalist plane is now pursued on an economic one. Where formerly princes sought to vanquish each other by risking their lives in bloody battles, they now risk their capital thorough the building of industrial empires.


...what has happened in the modern world is not simply the embourgeoisement of warrior cultures and the replacement of passions by interests, but also the spiritualization of economic life and the endowment of the latter with the same competitive energies that formerly fueled political life."

Two objections come immediately to (my) mind. First of all, it was only half a book ago that Fukuyama was arguing that French economic activity was stultified by too much influence from 'political' morals, one of many examples in the book where transfering the energies of political life to commerce was considered a bad thing.

Secondly, it's hardly the case that the world has seen an outbreak of peace since Hobbes wrote Leviathan. We haven't seen a World War since all of the major powers obtained nuclear weapons but I'm not sure that it's really reasonable to argue that this is the multi-century delayed flowering of the fruit of liberal democracy allowing people to build commercial empires instead of political ones.

* * *

In the end, Fukuyama covers a remarkable range of territory, but in so doing, I feel that he kind of weakened his point until it was hard to know exactly what point he was trying to make beyond noting that there are more large corporations in parts of the world where there are higher levels of trust and sociability, a point which probably didn't require 360 pages to make. Still, there's lots of interesting bits here and there which I tried to highlight in this post.

To finish off, here's an article from today's Wall Street Journal, the title reads "World Wealth Down 19.5% In '08,Wipes Out Two Year Gains" (deflation, anyone?) but I noted that in the body of the article was the following throwaway line, "While the world's wealth is still concentrated in three areas - U.S., Japan and Germany - the ranks are continuing to shift."

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Friday, June 19, 2009

Most One Sided Comment Thread Ever...

The 'liberal' media at work.

I've heard the theory expressed that the Republican party is in a death spiral in that, as moderates leave, the remainder becomes more wingnutty, which drives away more moderates and so on, until you end up with pretty much just crazy people in the party (i.e. the current situation), but it hadn't occurred to me until now that the same dynamic might play out in the media as well.

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Debt, Redux

"Your servant here, he has been told
to say it clear, to say it cold:
It's over, it ain't going
any further"

I keep writing this same post about the role of debt in the economy and the economic cycle, but I think the reason why I keep coming back to it from slightly different angles is that I am wary of being in disagreement with the majority of experts on a complicated topic about which I am not an expert. It seems as though adherents of the notion that our troubles stem from too much debt and will be cured by eliminating the debt come from the fringes on either the left or right, with few mainstream or 'establishment' figures supporting this notion.

At any rate, here goes.

Consider the game of Reversi, aka Othello. The fun in the game derives from the placement of pieces on the board – deciding which spot to occupy and when to occupy it is what the game is about. At the start of the game, the board is wide open and filled with possibilities. The game ends when the board is full, when there is nowhere left to place stones. At that point the only way to continue to enjoy playing Reversi is to clear the stones off the board and start over.

Now, consider the economy. Economic growth occurs as people invest money into producing goods and services. Generally, investment to support production involves taking on debt. Either people simply don't have enough money available to use as equity to start/expand production, or they figure that if the venture works out, higher leverage (more debt) will increase the return on their equity and if the venture doesn't work out (goes bust) then at least some of the money lost will be someone else's as opposed to their own.

Not everyone has the inclination or ability to go into debt to produce goods and services. In any society there is a mix of people who will and people who wont. For this post, let's call the people who will, entrepreneurs, and the people who won't, bankers (since the people who have savings place them in the bank, and the bank then lends those savings out – effectively anyone with savings is a banker).

To start with, imagine an economy with no debt* – it is like the Reversi board at the start of the game, filled with possibilities. All of the society's entrepreneurial types have no leverage (no debt) and the greatest ability to borrow (for a given level of equity) that they will ever have.

Then you set the economy in motion. As the entrepreneurs borrow and invest, the economy expands. This is equivalent to the placing of the stones on the Reversi board.

The problem is that, although individual entrepreneurs can and will succeed, as a whole they seem doomed to eventually fail. Over time, as the economy expands, both the entrepreneurs and the bankers grow more confident and the level of the entrepreneur's debt relative to their equity increases. i.e. Debt expands faster than the rate of economic growth. True, some entrepreneurs will go bankrupt, eliminating their debts, but there is a strong correlation between the individual entrepreneurs success or failure, so during the up part of the cycle when times are good, bankruptcies will be relatively rare.

Every now and then there is a breakthrough of some sort that allows higher than normal growth rates in a particular area. The invention of the steam engine and the railroad for example, or the development of the internet. These cases lead to an understandable gold rush where a mass of entrepreneurs piles in with their investments until they eventually blow a big bubble which collapses at some point once people realize that the investments have swamped the productive capacity of the new phenomenon (e.g. Once AOL's stock is so high that it can 'buy' Time Warner in a stock swap).

Sooner or later, whether due to a speculative mania or just a steady accumulation of good times and increasing risk tolerance, society reaches a point where the class of entrepreneurs has so much debt that they simply can't or won't take on any more. i.e. The Reversi board becomes full.

When the board is full, you have to clear the stones and start over, much like Solon did in Greece, back in the day. In economic terms, the debts must be eliminated or at least reduced.

Note that although it's certainly not very stable, and people do get hurt, especially in the cleaning stones off the board phase, there's nothing unsustainable about this cycle and the net result is positive (wiping out the debts doesn't wipe out the productive investments that the entrepreneurs have made). In every game the entrepreneurs take the risks and do the investing that builds up our wealth but eventually they lose and they can't play any more stones (take on any more debt) and they have to declare bankruptcy. For example, the Reichmans went bankrupt building Canary Wharf, but Canary Wharf is still there and the Reichmans were able to rebuild their fortune in the next cycle.

The role of the bankers is twofold:

While the stones are being played, they must try to direct the money they lend to the entrepreneurs with the best chance of making good investments with the money. This allows the entrepreneurs to do as much productive work as possible before they eventually lose out. In a sense, the role of the bankers is to try and expand the debt as much as possible while at the same time promoting as much growth as possible in order to sustain more and more debt.

The second role of the bankers in the cycle is to win gracefully. That is, when the game is over they must allow the stones to be cleared off the board so that the game can be replayed. Of course, clearing the stones off the board means wiping out all the accumulated money that the bankers are owed so this can be difficult. Deposit insurance was a progressive innovation designed to prevent small scale bankers (savers) from being wiped out in the process of stone removal so that the costs would fall heaviest upon the large scale bankers who would no doubt feel aggrieved but would still be handily able to clothe, feed and shelter themselves after having their stones removed.

In a sense, both sides are propelled forward by a certain perverse competitive behaviour. The entrepreneurs know that as a class they will eventually get in over their heads and fail, but each one believes that they will be one of the ones that succeeds. The bankers know that they can't accumulate claims against the entrepreneurs forever and that eventually most of the claims will have to be eliminated, but each one believes that they will lend to the entrepreneurs that succeed and that their claims will be preserved.

Besides, in the long run we are all dead, and both entrepreneurs and banks might as well enjoy the upside of the cycle while it lasts.

The question of the moment is what happens when the bankers refuse to win gracefully. What happens when, instead of allowing the stones to be removed from the board, they try to get blood from them instead?

Bankers can use the power of the government** to try and extend the game (or at least prevent it from being restarted) in a number of ways.

1) By lowering interest rates, they can reduce the burden of a given level of debt (sort of like shrinking the stones on the Reversi board so you can have more squares on the same board). The limiting case here is when government set interest rates reach 0.

2) You can substitute household borrowing for business borrowing. So when entrepreneurs can't or won't borrow any more, you encourage their customers to borrow instead (do not pay until 2017!). The resulting increased demand for their products will allow the entrepreneur to expand some more.

Eventually, however, the customers will in turn reach their limit with respect to capacity / willingness to borrow, and again, this can be extended by reducing rates, with a limiting case of 0 rates. (Note that this approach will direct investment towards the priorities of impatient consumers instead of towards whatever entrepreneurs see at the greatest unmet needs of people in general (in proportion to how much money they have, of course) – this may not be for the best).

3) By inflating asset prices, the perception (on both sides) of people's capacity to borrow can be increased, because the collateral is perceived to be worth more. Of course once asset prices get too high, they are vulnerable to a sudden loss of confidence followed by a crash. Where the limits are here is not known precisely and is a matter of psychology, but that they exist is certain.

4) Finally, when all else fails, the government itself can step into the shoes of the entrepreneurs and consumers and borrow for itself – up until the government also reaches its limit. This borrowing can either be done directly via government deficits or indirectly by either bribing or forcing entrepreneurs and consumers to borrow more. For example, if consumers have reached the limits of their willingness to take on mortgage debt, the government can guarantee their mortgage in order to tempt them with lower interest rates, and if the sweet, sweet offer of low interest rates is not enough to make them jump, then government can outright offer people an $8,000 bribe to buy a house. And if that doesn't work, try $15,000. Of course encouraging people to take on mortgage debt is a 2 for 1 deal in terms of expanding debt, since it expands household debt directly and also supports asset prices.

You can see that we have plowed our way through phases 1,2 and 3 and have reached the 4th and final option. Unwilling to allow any stones to be removed from the board (this would hurt the bankerseconomy!) the government (acting on behalf of the bankers) intends to put at least one stone of its own down for every stone that the private sector tries to remove. But sooner or later, the stones have to come off the board if we want to play again.

As I described above, we reach this final stage when entrepreneurs and their surrogates (consumers) have reached a point where they can't or won't borrow any more. The flip side of this, of course, is that it means bankers and their suppliers (people who save/lend money) have accumulated a massive amount of claims on the economy.

This relationship clarifies why we see such a strong historical relationship between inequality and debt crises. Also note that, if the government were to intervene on behalf of the entrepreneurs instead of on behalf of the bankers (e.g. by taking money from creditors and giving it to debtors), this would help to solve rather than aggravate the problem. Again, this clarifies why the period from the end of WW2 to the 70’s which had strongly progressive taxation was marked by unprecedented economic stability and the subsequent removal of this progressive taxation has brought us back to crisis. To put it simply, when the problem is that the bankers have all the money/claims on the economy, the only solution is to change this distribution.

As a society, we need to say to the bankers, ‘look, you win, let’s play again’. Either we wipe out the debts via bankruptcy or we inflate them away via bankruptcy or we redistribute income from bankers to entrepreneurs or we find some other way to reset the board. Naturally, this is not fair (Personally, I am a banker, not an entrepreneur – remember that we are including anyone who has net savings in the bank as a banker!), but fairness is beside the point – what must happen, will, and putting it off doesn't help. Of course, the bankers/savers will do almost anything to prevent this outcome, and they will try to convince us that we can grow our way out of the debts that we grew ourselves into (which we could if they were willing to accept interest rates below the rate of economic growth, but I'm not optimistic on this point, and even then it would take a long, long time).

The banker's incentive is to say that if entrepreneurs won't put any more stones on the board, then consumers will. If consumers won't do it then government will continue the game for them. Government will bribe people with low interests and cash payments for borrowing. If that doesn't work, the upper class bankers will direct the government to take the savings of the lower/middle class bankers via taxes and use that to support more government borrowing. But in the end, even holding all the political power, and controlling all the media, all the banker's kings will prove unable to keep Humpty Dumpty from falling off his wall.

The current game of 'run-up the debt' has been underway for decades. Maybe it can continue to be played, or at least held in stasis, for another year, or another decade, or even a couple of decades, I don't know. But someday, and the day is not too far off I fear/hope, we’ll hit that final, global, Minsky Moment when it’s over / it ain’t going any further.

* i.e. All money has zero maturity or pays no interest, like a $20 bill – holding it doesn’t require you to pay interest to anyone.

** I'm taking a break from the ethics series with this post, but note that the interference of bankers in government is exactly the sort of 'syndrome mixing' that Jane Jacobs identified as systemic corruption in 'Systems of Survival'.

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About Time

via Dr. Dawg, I see that Abousfian Abdelrazik will finally be coming home.

I guess they'll teach this one under the heading of 'importance of an independent judiciary' in the political science classes.

* * *

Previous posts on this topic here, here and here.


Thursday, June 18, 2009

16. Free-Riders

Note: This post is the sixteenth in a series. Click here for the full listing of the series.

In economic terms, a 'free rider' is a person who gets receives a benefit without contributing to the cost of generating of that benefit. The term derives from the notion of someone riding public transit without paying a fare. They are 'riding for free'.

In Mancur Olson's 'The Logic of Collective Action' which I covered in the last post, his idea was that as any group trying to generate a benefit grows larger, the temptation to free ride grows, and that rational self-interested people would not choose to cooperate in a group of this nature unless they were able to get some specific benefit from their cooperation (beyond the public good that their cooperation creates).

The Wikipedia entry offers the following example and possible solution,

"Suppose there is a street, on which 25 people live, and which suffers from a litter problem. A weekly street-cleaning service would cost $2,500 annually. Suppose that each person is prepared (i.e., able and willing) to pay $100 or more for the benefit of a cleaner street.

If the service is engaged, everyone will benefit. However, it is possible that some people on the street will refuse to pay, anticipating that the service will be undertaken in any event. Despite the fact they may be prepared to contribute $100, they will claim that they are not prepared to pay, and instead hope that others in the street will pay for the system anyway, and they receive the benefit for no personal expense.

As a result, it may happen that no system will be installed, an example of market failure. This is despite the fact that allocative efficiency would be improved.


One common solution to the problem is to gather the 25 participants and make them behave like one customer, so the decision is reduced from 25 independent decisions to one. A vote can be taken, but if the answer is yes, everyone will be forced to pay regardless of their individual support. This is why public services such as military defence and police service are almost exclusively provided by governments."

Note that the failure of a collective activity due to free rider incentives is a form of Prisoner's Dilemma, where people have an incentive to defect (free-ride) regardless of whether the other group members are cooperating or free-riding.

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Thursday, June 11, 2009

15. The Logic of Collective Action

Note: This post is the fifteenth in a series. Click here for the full listing of the series.

The Logic of Collective Action, by Mancur Olson, is a pretty straightforward book, at heart. There is one primary argument which is at once profound and straightforward:

Almost all group activity has a prisoner's dilemma type structure.

The argument is as follows:
1) People form groups to further their interests
2) The interests that the group is intended to further are non-excludable* in the sense that the benefits will accrue to all group members, regardless of their contribution towards achieving them.
3) People have an incentive to 'free ride' by getting the benefits of group membership while not contributing personally towards the achievement of group goals.

* Olson calls these public goods but acknowledges that the 'non-rival' component of the standard definition of public goods is not all that relevant to his argument

For example:

1) a labour union is formed to further its member's (the workers) interests.
2) the goals that the union pursues higher wages, better working conditions, etc. will go to all union members
3) Maintaining an effective union takes work (dues need to be paid to support it financially, people have to be willing to go on strike and forego their paycheck if necessary, etc.) and workers have an incentive to try and gain the benefits from the union without contributing towards achieving its objectives.

The notion is that if other people are going to cooperate (i.e. contribute towards group goals), then the best approach for a person is to defect or free-ride (i.e. not contribute towards group goals). And if other people aren't going to contribute towards group goals then you are still best off to also not contribute.

This is equivalent to the original Prisoner's Dilemma scenario where regardless of what your fellow prisoner does, the best option is to rat them out and confess.

Olson is primarily arguing against those who assume that group members always have individual interests that are aligned with the group interest.

Olson figures that in small enough groups, the members may each get enough benefit for it to be worth it to contribute (although contribution levels will still be less than the optimal or efficient level) but for larger groups there is unlikely to be any contributions (or any group) at all.

Taking the example of labour unions, Olson notes that historically unions started from small groups and only later merged into bigger organizations.

For large or 'latent' groups, as Olson calls them, to maintain themselves, they either need to make membership in the group mandatory to prevent free riding, or they need to provide a specific benefit to group members that justifies their membership beyond the public benefit. This is why unions want a closed shop and why professional associations (e.g. bar associations) want the same thing.

It is also why small groups of people with a common interest are often more powerful than large groups with a common interest. Olson notes that business lobbyists are effective within a particular industry, where there are typically only a handful of players, but lobby groups that represent business as a whole are weak because the individual members have little incentive to support the general business lobby group.

One way around this dilemma, Olson notes, is for large groups to use a federated structure, much in the way that most large unions are organized with locals and umbrella groups. Another similar option, that Olson doesn't mention, but I want to throw in so I don't forget about it later, is to use a hierarchical structure, where there are small groups that report to a single superior, and then a small group of superiors who report up to another higher superior, and so on.

Naturally, the larger the group, the less likely it is that you can count on everyone else to contribute, which in turn means the less likely you are to contribute so the harder it gets to achieve the group goals as the group gets larger.

On the topic of large groups, Olson notes that even the state, which can appeal to patriotism and which provides large economic benefits to the citizens by virtue of its existence, can not rely on voluntary contributions and instead must compel people to pay taxes.

Unfortunately, Olson does not pursue this further to inquire why, under a democracy where voters could presumably elect those politicians promising to eliminate taxes, taxes still remain, or to consider the possibility that a significant number of people are happy to pay taxes as long as they know that everybody else is paying a fair share as well - meaning that the compulsory nature of taxation might only be down to a small group of anti-social people who would try to free-ride. Or, in other words, the ironic prospect that it might only be due to the presence of libertarians that we need a coercive state.

We can see the limitations of Olson's concerns about the impossibility of collective action in large groups more clearly from a passage on page 64,
"Some critics may protest that even if social pressure does not exist in the large or latent group, it does not follow that the completely selfish or profit maximizing behaviour, which the concept of latent groups apparently assumes, is necessarily significant either; people might even in the absence of social pressure act in a selfless way. But this criticism of the concept of the latent group is not relevant, for that concept does not necessarily assume the selfish, profit-maximizing behaviour that economists usually find in the marketplace. The concept of the large or latent group offered here holds true whether behaviour is selfish or unselfish, so long as it is strictly speaking "rational".


"A man who tried to hold back a flood with a pail would probably be considered more of a crank than a saint, even by those he was trying to help. It is no doubt possible infinitesimally to lower the level of a river in a flood with a pail ... but the effect is imperceptible, and those who sacrifice themselves in the interest of imperceptible improvement may not even receive the praise normally due selfless behaviour."

It's hard to imagine a poorer choice of analogy. Anyone who's ever lived near a river, and even most who haven't, probably appreciates that you don't hold back a flood with a pail (what would you do with the water in your pail?), you hold back a flood with sandbags. I mention the word 'sandbag' and what mental image comes into your head? If you're like me it's the image of a large group of people working day and night often with the help of many selfless volunteers to build walls of sandbags to prevent a river from flooding a community - exactly what Olson is arguing will not happen.

Moving on, there's a very interesting passage on page 100 where Olson quotes at length from Hans Ritschl in 'Community Economy and Market Economy',
"The fatherland and mother tongue make us all brethren together. Anyone is welcome to the exchange society who obeys its regulations. But to the national community belong only the men and women of the same speech, of the same ilk, the same mind ... Through the veins of society streams the one, same money; through those of the community, the same blood...

Any individualist conception of "the State" is a gross aberration ... [and] nothing but a blind ideology of shopkeepers and hawkers.

The State economy serves the satisfaction of communal needs ... If the State satisfies needs which are purely individual, or groups of individual needs which can technically be met otherwise than jointly, it does so for the sake of revenue only.

In the free market economy the economic self-interest of the individual reigns supreme and the almost sole factor governing relations is the profit motive, in which the classical theory of the free market economy was appropriately and securely anchored. This is not changed by the fact that more economic units, such as those of associations, cooperatives or charities, may have inner structures where we find motivations other than self-interest. Internally, love or sacrifice, solidarity or generosity may be determining: but irrespective of their inner structures and the motives embodied therein, the market relations of economic units with each other are always governed by self-interest.

In the exchange society, then, self-interest alone regulates the relations of the members; by contrast, the state economy is characterized by communal spirit within the community. Egotism is replaced by the spirit of sacrifice, loyalty and communal spirit ... This understanding of the fundamental power of the communal spirit leads to a meaningful explanation of coercion in the state economy. Coercion is a means of assuring the full effectiveness of the communal spirit, which is not equally developed in all members of the community.

The objective collective needs tend to prevail. Even the party stalwart who moves into responsible government office undergoes factual compulsion and spiritual change which makes a statesman out of a party leader ... There is not a single German statesman of the last 12 years .. who escaped compliance with this law."

To which Olson comments,

"Ritschl's argument is exactly the opposite of the approach in this book. He assumes a curious dichotomy in the human psyche such that self-interest rules supreme in all transactions among individuals, whereas self-sacrifice knows no bounds in the individual's relationship to the state and to the many types of private organizations."

Personally, I was instantly struck by the echoes of Jane Jacobs 'Systems of Survival' in Ritschl's passage, with his references to an exclusive state sector with a spirit of loyalty, sacrifice, coercion and communal spirit in contrast with a cosmopolitan commercial sector open to all and characterized by pursuit of self-interest. Not to mention Olson's response describing Ritschl's 'curious dichotomy'!

Thinking of Jacobs helps us find the passage in Olson's work that reconciles his views with the 'exactly opposite' views of Ritschl - footnote 17 on page 61, which says,

"In addition to monetary and social incentives, there are also erotic incentives, psychological incentives, moral incentives and so on. To the extent that any of these types of incentives leads a latent [large] group to obtain a collective good, it could only be because they are or can be used as 'selective incentives," i.e., because they distinguish between those individuals who support action in the common interest and those who do not. Even in the case where moral attitudes determine whether or not people will act in a group-oriented way, the crucial factor is that the moral reaction serves as a "selective incentive." If the sense of guilt, or the destruction of self-esteem, that occurs when a person feels he has forsaken his moral code, affected those who had contributed toward the achievement of a group good, as well as those who had not, the moral code could not help to mobilize a latent group.

To repeat: the point is that moral attitudes could mobilize a latent group only to the extent they provided selective incentives. The adherence to a moral code that demands the sacrifices needed to obtain a collective good therefore need not contradict any of the analysis in this study; indeed this analysis shows the need for such a moral code or for some other selective incentive." (my italics)

So on page 100, Olson is baffled by Ritschl's argument that people will abide by a collectivist moral code when working in collective activities and a self-interested moral code when working in market activities, suggesting that this was the opposite of his argument.

But back on page 61, Olson came out and said that one way to overcome the problems of collective action was to employ a special moral code for collective activities which puts the group interest ahead of the selfish interest - something that his theory demonstrates the need for!

I'll close this post with a passage from David Hume's 'A Treatise of Human Nature' that Olson, in footnote 53 (many of the most important parts of the book are in the footnotes), says was pointed out to him by John Rawls,

"There is no quality in human nature which causes more fatal errors in our conduct, than that which leads us to prefer whatever is present to the distant and remote, and makes us desire objects more according to their situation than their intrinsic value. Two neighbours may agree to drain a meadow, which they possess in common; because it is easy for them to know each others mind; and each must perceive, that the immediate consequence of his failing in his part, is, the abandoning the whole
project. But it is very difficult, and indeed impossible, that a thousand persons should agree in any such action; it being difficult for them to concert so complicated a design, and still more difficult for them to execute it; while each seeks a pretext to free himself of the trouble and expence, and would lay the whole burden on others. Political society easily remedies both these inconveniences. Magistrates find an immediate interest in the interest of any considerable part of their subjects. They need consult no body but themselves to form any scheme for the promoting of that interest. And as the failure of any one piece in the execution is
connected, though not immediately, with the failure of the whole, they prevent that failure, because they find no interest in it, either immediate or remote. Thus bridges are built; harbours opened; ramparts raised; canals formed; fleets equiped; and armies disciplined every where, by the care of government, which, though composed of men subject to all human infirmities, becomes, by one of the finest and most subtle inventions imaginable, a composition, which is, in some measure, exempted
from all these infirmities."

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Sunday, June 07, 2009

14. Public Goods

Note: This post is the fourteenth in a series. Click here for the full listing of the series.

A concept that will be useful for the next book review is the economic notion of 'public goods'

I'll let wikipedia do the explaining:

'In economics, a public good is a good that is non-rivaled and non-excludable. This means, respectively, that consumption of the good by one individual does not reduce availability of the good for consumption by others; and that no one can be effectively excluded from using the good. ...

For example, if one individual drinks a milkshake, there is no milkshake left for anyone else, and it is possible to exclude others from consuming the milkshake; it is a rivaled and excludable private good. Conversely, breathing air neither significantly reduces the amount of air available to others, nor can people be effectively excluded from using the air. This makes it a public good'

So you have four possibilities:

1) A good can be 'rival' (meaning if I take some, there's less for you) and 'excludable' (the provider can control who the recipients are) - private goods

Example: The milkshake, most basic goods such as TV's, toasters, etc.

2) A good can be 'rival' (if I take some there's less for you) and 'non-excludable' (provider can't control who the recipients are)

Example: Natural resources that are held in common, such as fish in the ocean.

3) A good can be 'non-rival' (taking some doesn't diminish what is available) and 'excludable' (provider can control who the recipients are)

Example: Information that can be limited to certain recipients, e.g. Cable television

4) A good can be 'non-rival' (taking some doesn't diminish what is available) and 'non-excludable' (provider can't control who the recipients are) - these are public goods

Example: Broadcast television, information goods that can't be limited to certain recipients (e.g. songs in the internet era)

Note that non-excludable goods, especially those with a high cost of provision, are less likely to be provided by a private party due to the inability of preventing people who won't contribute to the cost of provision from receiving the benefits. i.e. the presence of free-riders.

This is why non-excludable goods tend to be provided by government (and are known as public goods, where they are non-rival), because only government has the power to compel all people, including wouldbe free riders to support the provision of beneficial goods that would otherwise go unproduced.

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Thursday, June 04, 2009

Deja Vu

All of this has happened before
All of this will happen again...

Here's a quote that seems relevant to the current financial situation,

"Another way of defining moral hazard is that it is what results from the combination of privatized profit an socialized loss. In the words of Kenneth A. Guenther, executive vice president of the Independent Bankers Association of America, "The combination of interest rate deregulation with 100% deposit insurance is like the invention of gunpowder - sooner or later it was bound to explode" But deregulation of banking and finance was all the rage ... and the banking sector wanted "the government off its back." Nowadays the last thing it wants is for the government to leave the scene of the train wreck. Ironically, the degree of government involvement in the financial sector ... is proving much greater than before. ... Those deemed 'too big to be allowed to fail' are of course especially favoured, further encouraging bigness.


To analyze or even recount the recent and unfinished consequences of the financial deregulation disaster in the United States, or the international debt crisis, is far beyond our scope. We are sure that the consequences will eventually have to include a large dose of reregulation in the public interest."

That's Herman Daly and John Cobb from the 2nd edition of 'For the Common Good', published in 1994. I wouldn't be too optimistic about that reregulation bit, we're just going to go from crisis to crisis without anything changing if the last few decades are anything to go by...

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Abdelrazik Update

Note: Previous post on this topic is here.

The Conservative party was smacked down pretty hard today by the Federal Court, which ruled that,

"Mr. Abdelrazik, who has been marooned in Sudan for nearly six years, “is as much a victim of international terrorism as the innocent persons whose lives have been taken by recent barbaric acts of terrorists,” Judge Zinn said."


"Judge Zinn found that while it wasn't necessary for him to determine whether the government has acted in bad faith to violate Mr. Abdelrazik's rights and thwart his return, the evidence supports such a conclusion.

“Had it been necessary to determine whether the breach was done in bad faith, I would have had no hesitation making that finding on the basis of the record before me,”"


"Judge Zinn's message was tougher. He ordered Ottawa to “take immediate action so that Mr. Abdelrazik is returned to Canada,” requiring the government to issue him an emergency passport, make travel arrangements within 15 days and get him home within 30 days. To drive home the point, Judge Zinn told the government to ensure that Mr. Abdelrazik appears before him no later than July 7."

Dr. Dawg has more.

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Tuesday, June 02, 2009

The Paperless Office

...has finally arrived. For me, anyway. Other than the odd long document that I need to review in depth, I'm pretty much paper free these days. Still no flying cars though.

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