84. Hierarchy, Obedience and Largesse

Note: This post is the eighty-fourth in a series about government and commercial ethics. Click here for the full listing of the series. The first post in the series has more detail on the book 'Systems of Survival' by Jane Jacobs which inspired this series.

Last post, I talked about how we model the precept of 'Be loyal'. This week, let's look at a cluster of other Guardian syndrome precepts, 'Dispense Largesse, 'Respect Hierarchy' and 'Be Obedient'

In a lot of ways, the Commercial and Guardian syndromes are opposites. The commercial syndrome shuns force and upholds honesty while the Guardian syndrome lauds force and deception when used to advance our shared interests. The Commercial syndrome calls for efficiency while the Guardian syndrome calls for rich use of leisure and so on.

The topic of hierarchy is another instance of this opposition. While the Guardian syndrome includes military-type hierarchical precepts such as 'Respect Hierarchy' and 'Be Obedient and Disciplined,' the commercial syndrome calls for 'Dissent for the sake of the task' and 'Come to Voluntary Agreements.'

In what sort of situation is a hierarchy useful? As Joseph Heath points out in 'The Efficient Society' it seems like there are a lot of such situations, as most of our life, our working life in particular, revolves around hierarchical structures. Heath figures that the hierarchy is more efficient and that, "The most effective hierarchies are ones in which subordinates have enough loyalty to the organization and to its leadership that they obey without needing to be forced" (emphasis added).

Heath adds that hierarchy's core virtue is that, "it helps us to avoid collective action problems"

By 'collective action problems' Heath is referring to prisoner's dilemma situations with multiple participants.

But what is meant by more efficient. In his book 'The Efficient Society' Heath generally means Pareto efficient (meaning some people are better off, nobody is worse off) but he's not specific in his discussion of hierarchy.

The classic prisoner's dilemma looks like the following:



Let's assume for now that without a hierarchical structure, Bob and Doug would end up in the uncooperative outcome with a total result of 2 (1 each) but that by forming a hierarchical structure with Bob in charge, now they end up at the 'cooperative' outcome with a total result of 10.



But whereas in the standard cooperative resolution the fruits are divided based on some predetermined formula, in this case the person at the top of the hierarchy could, by virtue of their superior rank, simply take the whole 'cooperative' result for themselves. If this were to happen, then the final outcome would still be efficient in this sense of achieving the best total result possible, but it would no longer be Pareto-efficient in the sense of providing a gain to all involved. The sucker at the bottom of the hierarchy ends up worse off than before.

Within the altered world of hierarchy, it makes sense for Doug to cooperate, even getting nothing out of the deal (because now Bob is his superior/boss and can punish him if he doesn't cooperate), but he'd be better off scrapping the whole notion of the hierarchy (i.e. starting a revolution) and going back to how things were before.

Commercially minded folks (e.g. economists) will be thinking to themselves that this can't happen because then the underling will just go somewhere else where they can get a better deal. But that's commercial thinking - in the guardian world, there is no 'competition' and there is nowhere else to go

In the Guardian world, the recourse is not to competition, but to force. In order to secure continued obedience Bob could resort to force as well, but it would probably be better for everyone if he instead decided to share some of the cooperative gain with Doug.

Thus brings us to the final precept I wanted to discuss in this post, 'Dispense Largesse.' The current round of uprisings in the Middle East is showing the difference between places (Oman, Jordan, UAE) where leaders practiced the guardian precept of dispensing largesse and places like Tunisia and Libya where leaders instead accumulated billions of dollars in their own private bank accounts (obviously there's a lot more going on, but I feel confident that the role of largesse is certainly a factor).

In game theory terms, the largesse plays a critical role in securing buy in (obedience and respect for) a hierarchical arrangement which is more efficient in dealing with Prisoner's Dilemma type situations. We end up with something like the following:



Maybe it doesn't seem completely fair (who put Bob in charge, anyway?) but everyone is better off (in absolute, if not in relative terms) under the new hierarchical system than they were in the old uncooperative outcome.

The Home Ownership Scam

Worth repeating, Willem Buiter on the social benefits of home ownership:

Home Loans in the U.S. the Biggest Racket Since Al Capone:

...Why do politicians of all political colours and parties get their knickers so twisted about people losing their homes? In the case of the Tories in the UK and the Republicans in the US, the answer is obvious. Both parties believe that home owners are conservative. Not it the sense that people who are inherently conservative are more likely to become homeowners (although they may believe that as well). This is not a selection story but an osmosis story. Home ownership makes people more conservative. So both Tories and Republicans do everything they can to encourage home ownership. But so do (New) Labour in the UK and the Democrats in the US, so it’s no longer a left-right thing.

The one argument for encouraging home ownership that makes sense is that owner-occupiers look better after their property and its immediate surroundings than would a tenant. This is a simple principal-agent story where it is costly for the principal (the owner) to monitor the care and attention the agent (the tenant) bestows on his property. Add some neighbourhood externalities (I don’t want to live next door to a place where they don’t mow the lawn or paint the exterior of the house), and you have an argument for encouraging owner-occupancy, say by subsidising it.

But a subsidy for owner-occupancy is something completely different from subsidising borrowing using residential real estate as collateral. If they exist, the benefits from owner-occupancy are there regardless of whether the owner-occupier has a mortgage or not. It doesn’t matter whether she borrowed to buy the house, paid in cash, stole it, inherited it from her parents, or built it with sweat equity on land won in a raffle. The US does not encourage owner-occupancy directly, say by paying each head of household who is an owner-occupier, a given amount of cash each year. Instead it encourages and subsidises a particular form of borrowing, regardless of what that borrowing is spent on. Funds, after all, are fungible. I can withdraw equity from my house by taking out a first or second mortgage against it, or by increasing the size of an existing mortgage, and spend the proceeds on Cuban cigars.

All this is rather insane. Through the deductibility of mortgage interest from taxable income, the US tax payer gives vast subsidies to borrowing secured against a particular type of collateral - residential real estate. What so special about this borrowing and this collateral? Fortunately, the UK has abolished this boondoggle. In the US, other forms of preferential treatment for home ownership are piled on top of the mortgage interest-deductibility. Over half the stock of home loans, and virtually all new home lending in the US are heavily subsidized by the lending and guarantees of Fannie Mae, Freddie Mac, Ginnie Mae and assorted smaller smaller government agencies. The direct interventions of the Fed and the Treasury in the market for residential mortgage-backed securities, announced as part of the credit-easing policies of the Fed represent further quasi-fiscal subsidies to housing finance.

This is on top of the creation by the Fed of at least a dozen facilities that accept RMBS as collateral for Fed loans in the earlier stages of the financial crisis. All these quasi-fiscal interventions by the GSEs and the Fed are deeply non-transparent as regards the magnitude of the subsidies involved. They also evade the normal scrutiny and accountability to Congress that is associated with explicit subsidies by the Treasury. The only priviliged treatment of residential housing that makes a modicum of sense from the perspective of encouraging owner-occupancy (as opposed to borrowing to fund whatever expenditures using residential housing as collateral), is the ability to postpone capital gains taxation on the sale of one’s principal residence, and to have one capital-gains-tax-free realisation during one’s lifetime (taken generally when people size down on retirement or when the kids have flown from the nest).

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US. There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment. It is time to correct the distorted incentives that are at the root of this misallocation. The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages. A focused social housing program is of course a legitimate activity of the Federal government. It should be on-budget, that is, fiscal rather than quasi-fiscal.

...

But really, you should read the whole thing...

Buiter does a great job exposing the madness behind out-of-hand government promotion of home ownership, but he doesn't really get into the question of why governments act this way.

And it's not just the U.S. - Canada has gone down the same road with CMHC and a host of other incentives.

And over here, Steve Keen catalogues the extensive list of government interventions in Australia and again has little explanation for the magnitude of the government intervention in this particular area.

I do have a theory on why governments find this area particularly irresistible, but I'll have to save it for a few weeks until I've developed the appropriate background material first.