Streetwise Professor

July 19, 2016

Paths to Redemption and the Differential Susceptibility of Religions to Terrorism

Filed under: Economics,History,Politics — The Professor @ 6:57 pm

Many human conflicts and struggles are universal, but they manifest themselves very differently in different cultures. One universal struggle is between religion and morals and carnal desire. Religions and cultures differ in how sins can be redeemed, and this strongly shapes how this conflict is resolved.

In evangelical Christianity, one manifestation of this struggle is extreme hypocrisy. As La Rochefoucault said, “hypocrisy is the tribute [or homage] that vice pays to virtue.” Public acknowledgement of sin, pledges of a devotion to Christ as the redeemer of sins, and efforts to bring other sinners to Christ are all paths to redemption. The greatest sinners, and those upon whom sins weigh most heavily (in large part because they have internalized the religion’s moral code), are often the most profuse in their public acknowledgements, most intense in their pledges, and most driven in their evangelizing efforts. This is what produces types epitomized in fiction by Elmer Gantry, and in real life by the likes of Jimmy Swaggert. Bible thumpers in public, drunkards and perverts in private.

For many Muslims, martyrdom in jihad against infidels is a path to redemption of sin. Many strongly believe that dying while killing in the name of Allah is a get out of hell free card.

This comes to mind after reading a story about the mass murderer in Nice, who was apparently violent, a drug abuser, a man with an “out of control sexual life” (including bisexuality–with septuagenarians!), and a violator of Muslim dietary strictures. His sordid and dissolute and unobservant life is being seized upon to claim that since he “did not practice the Muslim religion,” Islam is absolved of any role in his heinous acts, and could not have been his motivation.

To the contrary. The fact that Muslims believe that martyrdom in waging jihad against infidels is a path to redemption means that a widely-held set of Islamic beliefs contributes directly to the murderous acts of  men like Mohamed Bouhlel. It is precisely those whose sins are so great who are most in need of redemption, and who are most likely to turn to suicide terrorism as a means of obtaining it. That’s a path offered to them by their culture and religion.

Such tortured individuals are the most susceptible to the proselytizing efforts of ISIS and its ilk. These are the people who are most vulnerable to online radicalization. These are the people who are the perfect prey for radical recruiters who can readily exploit the intense cognitive dissonance of the extreme sinner who wants to be a good Muslim.

I therefore hypothesize that suicide terrorists and recruits to terrorist groups will be disproportionately “bad Muslims”: criminals, heavy drug users, and sexual deviants (where deviance is defined by Muslim mores). An unsystematic recollection of some notable cases (e.g., the 911 hijackers) provides support to this hypothesis, but it deserves more systematic testing. (There is conflicting information on whether Orlando shooter Omar Mateen is consistent with they hypothesis.)*

Violent, drug abusing, sexual deviants are less of a concern when they are utterly amoral, and uninterested in redemption in the confines of any religion: they harm mainly themselves, a small circle of people around them, and sometimes an unfortunate stranger. They become dangerous when such people believe in a religion that offers redemption through violent action. Then large numbers of random strangers are at risk. Eighty-three corpses in Nice are only the most recent example of that.

Religions differ in the ways that they allow adherents to resolve the conflict between belief and sinfulness, and the way that Islam allowed Mohamed Bouhlel to resolve his conflict poses a grave risk to the societies in which men like him live. Europe generally, and France in particular, are at great risk because they have large populations of young, unattached, and alienated Muslim men with high rates of criminality, drug abuse, and other anti-social behaviors. Combined with ubiquitous online proselytization and a network of (often very ascetic) recruiters (including recruiters in prison), this is a combustible mix. This population isn’t going anywhere, and in fact is growing due to Europe’s immigration choices, economic malaise, and demonstrated incompetence at integrating immigrants. Islam isn’t going anywhere either, and shows no signs of leaving behind martyrdom as a path to redemption. To the contrary, Wahhabism and other fundamentalist strains of Islam are ascendent, due in no small part to massive Saudi spending to spread them.

Connect these dots, and you draw a very disturbing picture. Neither of the two things that combine to create terrorism are readily amenable to change, and if anything appear to be growing in virulence. That portends ill for the future, not just in France, but world-wide.

* There can be another causal mechanism that would create such a correlation. A game theoretic explanation of strictures against suicide in Catholicism where sins can be absolved by confession is that absent eternal damnation for suicide, one could commit mortal sins to one’s heart’s content, confess, commit suicide immediately afterward, and go to heaven. Thus, damnation for suicide is necessary to make afterlife punishments for other sins a credible deterrent when confession absolves sins. If martyrdom while committing a terrorist act absolves one for other sins, the punishments for these other sins are less credible, and they are more likely to be committed, and martyrdom through violence is also more likely.

 

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July 17, 2016

Antitrust to Attack Inequality? Fuggedaboutit: It’s Not Where the Money Is

Filed under: Economics,Politics,Regulation — The Professor @ 12:09 pm

There is a boomlet in economics and legal scholarship suggesting that increased market power has contributed to income inequality, and that this can be addressed through more aggressive antitrust enforcement. I find the diagnosis less than compelling, and the proposed treatment even less so.

A recent report by the President’s Council of Economic Advisors lays out a case that there is more concentration in the US economy, and insinuates that this has led to greater market power. The broad statistic cited in the report is the increase in the share of revenue earned by the top 50 firms in broad industry segments. This is almost comical. Fifty firms? Really? Also, a Herfindahl-Hirschman Index would be more appropriate. Furthermore, the industry sectors are broad  and correspond not at all to relevant markets–which is the appropriate standard (and the one embedded in antitrust law) for evaluating concentration and competition.

The report then mentions a few specific industries, namely hospitals and wireless carriers, in which HHIs have increased. Looking at a few industries is hardly a systematic approach.

Airlines is another industry that is widely cited as experiencing greater concentration, and which prices have increased with concentration. Given the facts that a major driver of concentration has been the bankruptcy or financial distress of major carriers, and that the industry’s distinctive cost characteristics (namely huge operational leverage and network structure) create substantial scale and network economies, it’s not at all clear whether the previous lower prices were long run equilibrium prices. So some of the price increases may result in super competitive prices, but some may just reflect that prices before were unsustainably low.

Looking over the discussion of these issues gives me flashbacks. There is a paleo industrial organization (“PalIO”?) feel to it. It harkens back to the ancient Structure-Conduct-Performance paradigm that was a thing in the 50s-70s. Implicit in the current discussion is the old SCP (LOL–that’s the closest I come to being associated with this view) idea that there is a causal connection between industry structure and market power. More concentrated markets are less competitive, and firms in such more concentrated, less competitive markets are more profitable. Those arguing that greater concentration increases income inequality go from this belief to their conclusion by claiming that the increased market power rents flow disproportionately to higher income/wealth individuals.

The PalIO view was challenged, and largely demolished, in the 70s and 80s, primarily by the Chicago School, which demonstrated alternative non-market power mechanisms that could give rise to correlations (in the cross-section and time series) between concentration and profitability. For instance, firms experiencing favorable “technology” shocks (which could encompass product or process innovations, organizational innovations, or superior management) will expand at the expense of firms not experiencing such shocks, and will be infra marginal and more profitable.

This alternative view forces one to ask why concentration has changed. Implicit in the position of those advocating more aggressive antitrust enforcement is the belief that firms have merged to exploit market power, and that lax antitrust enforcement has facilitated this.

But there are plausibly very different drivers of increased concentration. One is network and information effects, which tend to create economies of scale and result in larger firms and more concentrated markets. Yes, these effects may also give the dominant firms that benefit from the network/information economies market power, and they may charge super competitive prices, but these kinds of industries and firms pose thorny challenges to antitrust. First, since monopolization per se is not an antitrust violation, a Google can become dominant without merger or without collusion, leaving antitrust authorities to nip at the margins (e.g., attacking alleged favoritism in searches). Second, conventional antitrust remedies, such as breaking up dominant firms, may reduce market power, but sacrifice scale efficiencies: this is especially likely to be true in network/information industries.

The CEA report provides some indirect evidence of this. It notes that the distribution of firm profits has become notably more skewed in recent years. If you look at the chart, you will notice that the return on invested capital excluding goodwill for the 90th percentile of firms shot up starting in the late-90s. This is exactly the time the Internet economy took off. This resulted in the rise of some dominant firms with relatively low investments in physical capital. More concentration, more profitability, but driven by a technological shock rather than merger for monopoly.

Another plausible driver of increased concentration in some markets is regulation. Hospitals are often cited as examples of how lax merger policy has led to increased concentration and increased prices. But given the dominant role of the government as a purchaser of hospital services and a regulator of medical markets, whether merger is in part an economizing response to dealing with a dominant customer deserves some attention.

Another industry that has become more concentrated is banking. The implicit and explicit government support for too big to fail enterprises has obviously played a role in this. Furthermore, extensive government regulation of banking, especially post-Crisis, imposes substantial fixed costs on banks. These fixed costs create scale economies that lead to greater scale and concentration. Further, regulation can also serve as an entry barrier.

The fixed-cost-of-regulation (interpreted broadly as the cost of responding to government intervention) is a ubiquitous phenomenon. No discussion of the rise of concentration should be complete without it. But it largely is, despite the fact that it has long been known that rent seeking firms secure regulations for their private benefit, and to the detriment of competition.

The CEA study mentions increased concentration in the railroad industry since the mid-80s. But this is another industry that is subject to substantial network economies, and the rise in concentration from that date in particular reflects an artifact of regulation: before the Staggers Act deregulated rail in 1980, that industry was inefficiently fragmented due to regulation. It was also a financial basket case. Much of the increased concentration reflects an efficiency-enhancing rationalization of an industry that was almost wrecked by regulation. Some segments of the rail market have likely seen increased market power, but most segments are subject to competition from non-rail transport (e.g., trucking, ocean shipping, or even pipelines that permit natural gas to compete with coal).

Another example of how regulation can increase concentration and reduce concentration in relevant markets: EPA regulations of gasoline. The intricate regional and seasonal variations in gasoline blend standards means that there is not a single market for gasoline in the United States: fuel that meets EPA standards for one market at one time of year can’t be supplied to another market at another time because it doesn’t meet the requirements there and then. This creates balkanized refinery markets, which given the large scale economies of refining, tend to be highly concentrated.

Reviewing this makes plain that as in so many things, what we are seeing in the advocacy of more aggressive antitrust is the prescription of treatments based on a woefully incomplete understanding of causes.

There is also an element of political trendiness here. Inequality is a major subject of debate at present, and everyone has their favorite diagnosis and preferred treatment. This has an element of using the focus on inequality to advance other agendas.

Even if one grants the underlying PalIO concentration-monopoly profit premise, however, antitrust is likely to be an extremely ineffectual means of reducing income inequality.

For one thing, there is no good evidence on how market power rents are distributed. The presumption is that they go to CEOs and shareholders. The evidence behind the first presumption is weak, at best, and some evidence cuts the other way. Moreover, it is also the case that some market power rents are not distributed to shareholders, but accrue to other stakeholders within firms, including labor.

Moreover, the numbers just don’t work out. In 2015, after-tax corporate income represented only about 10 percent of US national income. Market power rents represented only a fraction of those corporate profits. Market power rents that could be affected by more rigorous antitrust enforcement represented only a fraction–and likely a small fraction–of total corporate profits. If we are talking about 1 percent of US income the distribution of which could be affected by antitrust enforcement, I would be amazed. I wouldn’t be surprised if its an order of magnitude less than that.

With respect to how much of corporate income could be affected by antitrust policy, it’s worthwhile to consider a point mentioned earlier, and which the CEA raised: the distribution of corporate profits is very skewed. Further, if you look at the data more closely, very little of the big corporate profits could be affected by more rigorous antitrust–in particular, more aggressive approaches to mergers.

In 2015, 28 firms earned 50 percent of the earnings of all S&P500 firms. Apple alone earned 6.7 percent of the collective earnings of the S&P500. Many of the other firms represented in this list (Google, Microsoft, Oracle, Intel) are firms that have grown from network effects or intellectual capital rather than through merger for market power. They became big in sectors where the competitive process favors winner-take-most. It’s also hard to see how antitrust matters for other firms, Walt Disney for instance.

Only three industries have multiple firms on the list. Banking is one, and I’ve already discussed that: yes, it has grown through merger, but regulation and government are major drivers of that. There have also efficiency gains from consolidating an industry that regulation historically made horrifically inefficiently fragmented, though where current scale is relative to efficient scale is a matter of intense debate.

Another is airlines. Again, given the route network-driven scale economies, and the previous financial travails of the industry, it’s not clear how much market power rents the industry is generating, and whether antitrust could reduce those rents without imposing substantial inefficiencies.

Automobiles is on the list. But the automobile industry is now far less concentrated than it used to be in the days of the Big Three, and highly competitive.  Oil is represented on the list by one company: ExxonMobil. Crude and gas production is not highly concentrated, when one looks at the relevant market–which is the world. This is another industry which has seen a decline in dominance by major firms over the years.

Looking over this list, it is difficult to find large dollars that could even potentially be redistributed via antitrust. And given that this list represents a very large fraction of corporate profits, the potential impact of antitrust on income distribution is likely to be trivial.

(As an exercise for interested readers: calculate industry profits by a fairly granular level of disaggregation by NAICS code, and see which ones have become more concentrated as a result of merger in recent years.)

In sum, if you want to ameliorate inequality, I would put antitrust on the bottom of your list. It’s not where the money is because the kind of market power that antitrust could even conceivably address accounts for a  small portion of profits, which in turn account for a modest percentage of national income. Market power changes in many profitable industries have almost certainly been driven by major technological changes, and antitrust could reduce them only by gutting the efficiency gains produced by these changes.

 

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July 13, 2016

Which Side is Obama on? Now We Know: Feeding the Flames of Racial Discord

Filed under: Politics — The Professor @ 5:20 pm

Obama’s greatest opportunity as president was to advance race relations in this country. They have obviously improved almost miraculously since the Civil Rights and Jim Crow eras, but in 2008 they could have definitely improved even further. Sadly, in the past seven plus years, they have regressed rather than progressed. Obama squandered an opportunity that he was uniquely placed to exploit.

Uniquely placed, but sadly not uniquely qualified, as events have made all too clear. For rather than pour oil on troubled waters, Obama has thrown it on the fire. He does it with such regularity that I must conclude that is hardwired, or a conscious choice: which is worse, I can’t say. The horrific events of the past days represent the zenith of this behavior–at least I hope so.

The crux of the problem is that Obama is an echo chamber for Black Lives Matter memes, and a defender of and advocate for the organization. BLM is a divisive, confrontational, and frankly racist organization that is exacerbating tensions, rather than doing anything to reduce them, or to correct the underlying problems. BLM marches routinely involve chants advocating the murder of police (“Pigs in a blanket, fry ’em like bacon”). Obama has hosted leaders of this group at the White House, and praised their effectiveness, saying that he was “confident that they are going to take America to new heights.” A sobering thought, that.

The less incendiary part of BLM rhetoric is still fundamentally dishonest, and it is this part that Obama repeats on every occasion in which these issues are even tangentially relevant–or sometimes when they are appallingly inappropriate, as at the memorial service in Dallas yesterday. In particular, the BLM/Obama rhetoric cites racial disparities in deaths in confrontations with police; arrest and incarceration rates; and capital sentencing rates as evidence of deep-seated “institutional racism.”

These statistics–and those citing them–are fundamentally dishonest because these numbers are clearly not the whole truth, and fractional truths (I will not dignify them by calling them “half-truths”) can be as manipulative and misleading as an outright lie. These certainly are.

Telling the whole truth would require confronting an ugly reality: there are substantial racial disparities in criminality (and in rates of victimization–a fact BLM is outrageously silent about with the exception of police killings).

Take, for instance, the oft-repeated statistic that African Americans represent a proportion of those killed by police that is double their proportion of the population. But they commit murder in a proportion four times that of their share of the population: and they also are victimized by murder in a similarly disproportionate ratio (which should be your major concern if you truly believe black lives matter). In every statistic related to violent crime, African Americans are disproportionately represented as both perpetrators and victims–and in ratios that typically exceed the 2-1 police killing statistic. This is true in the case of murders of police officers, where African Americans are the killer 43 percent of the time, in contrast to their 12 percent share of the population: they make up about 26 percent of those killed by police.

These hard facts have hard implications that speak directly to how to interpret statistics not just on arrest and incarceration rates, but on deaths at the hands of law enforcement. Namely, because of their greater involvement in crime, African Americans are  disproportionately likely to have hostile interactions with law enforcement. Further, police will rationally infer, based on the limited information that they inevitably have to act on, that all else equal African Americans pose a greater threat to  them than do non-African Americans. This makes a bad outcome more likely when a police officer confronts an African American than when confronting someone of a different race.

Most of the law enforcement shootings are ruled justified. But citing statistics embracing all shootings, and failing to put those into the sad context of life in many minority neighborhoods in the United States, BLM–and Obama and the left generally–insinuate that they are prima facie evidence of racial injustice.

This is a pattern for Obama. Further, he routinely expresses tendentious opinions about controversial cases, some of which (Trayvon Martin) are hard cases, and some of which (the shooting of Michael Brown) prove not to be, once the facts are known (often only after a Herculean effort to rescue those facts from mendacious misinformation). After Ferguson, Obama told the UN–the UN!–the following:

I realize that America’s critics will be quick to point out that at times we too have failed to live up to our ideals; that America has plenty of problems within its own borders.  This is true.  In a summer marked by instability in the Middle East and Eastern Europe, I know the world also took notice of the small American city of Ferguson, Missouri — where a young man was killed, and a community was divided.

A low, dishonest characterization, that. One that slyly embraces the utterly false narrative about the death of Michael Brown. For although Obama describes the death in the passive voice (“a young man was killed”) and does not identify the killer, this is of little moment when (a) everyone knows that the “young man” was black and he was killed by a white policeman, and (b) this episode was raised in a paragraph beginning with an admission that American has “failed to live up to our own ideals.” The judgment that Obama renders about Brown’s death in that paragraph is blindingly obvious, regardless of the Delphic phrasing. Indeed, by comparison the rhetoric of BLM is refreshingly honest and preferable in that respect.

This tendency was on display again in the aftermath of two police shootings in the last week, one in Baton Rouge the other in a Minneapolis suburb. Speaking about the second episode, the death of Philando Castile, Obama repeated the as yet uncorroborated statements of Castile’s girlfriend, who was in the car with him when he was shot. The live stream she put on Facebook was indeed disturbing, but it starts after Castile was shot, and as yet we know not what chain of events culminated in the shooting: we have just heard her version. But without knowing the facts, Obama validated the narrative that the shooting was unjustified, and then used the tragedy as another opportunity to deliver a soliloquy on racial disparities in the American criminal justice and law enforcement systems.

This rush to judgment contrasted jarringly with Obama’s reticence to pass judgment on the motives of the mass killer of five Dallas policemen despite the fact that the (black) police chief of Dallas had said that the murderer–Micah Xavier Johnson–had expressed his solidarity with BLM, his hatred of whites, and his intention to kill white police officers. Obama’s reticence to interpret Johnson’s avowed motives also clashed with his easy assertion that Charleston church shooter Dylann Roof was driven by racial hatred.

Speaking yesterday at a memorial service for the officers, Obama did acknowledge Johnson’s racism: he really had little choice after the blowback from his initial claim that Johnson’s intent was inscrutable (and his previous refusal to acknowledge the avowed motives of Muslim murderers in Orlando and San Bernardino). But the speech was nonetheless another exercise in his obfuscation of realities in order to insinuate pervasive institutional racism. He mentioned Philadro Castile and Baton Rouge shooting victim Alton Sterling in the same sentence as the five dead officers, thereby drawing a sort of equivalence where none exists, other than the fact that people are dead. But it got worse:

But America, we know that bias remains. We know it, whether you are black, or white, or Hispanic, or Asian, or native American, or of Middle Eastern descent, we have all seen this bigotry in our own lives at some point. We’ve heard it at times in our own homes. If we’re honest, perhaps we’ve heard prejudice in our own heads and felt it in our own hearts. We know that. And while some suffer far more under racism’s burden, some feel to a far greater extent discrimination’s stain. Although most of us do our best to guard against it and teach our children better, none of us is entirely innocent. No institution is entirely immune, and that includes our police departments. We know this.

And so when African-Americans from all walks of life, from different communities across the country, voice a growing despair over what they perceive to be unequal treatment, when study after study shows that whites and people of color experience the criminal justice system differently. So that if you’re black, you’re more likely to be pulled over or searched or arrested; more likely to get longer sentences; more likely to get the death penalty for the same crime. When mothers and fathers raised their kids right, and have the talk about how to respond if stopped by a police officer — yes, sir; no, sir — but still fear that something terrible may happen when their child walks out the door; still fear that kids being stupid and not quite doing things right might end in tragedy.

When all this takes place, more than 50 years after the passage of the Civil Rights Act, we cannot simply turn away and dismiss those in peaceful protest as troublemakers or paranoid.

Again, the recitation of incomplete and decontextualized statistics in the most inflammatory–and inappropriate–circumstances. Suggesting that law enforcement is racist at the funerals of five policemen (killed by an admitted racist, no less) is to insinuate that as part of that system these officers were racist too.

One particularly outrageous line is another BLM theme: “When mothers and fathers raised their kids right, and have the talk about how to respond if stopped by a police officer — yes, sir; no, sir — but still fear that something terrible may happen when their child walks out the door.” Tragically, something terrible may indeed happen to those children with shocking likelihood, but it is orders of magnitude more likely that the perpetrator of the terrible thing will not be a policeman, but another African American. And what about all those children whose mother and father did not raise them right, and all too often don’t raise them at all? Obama’s framing is yet another denial of some very unpleasant realities.

In the aftermath of the Trayvon Martin death, Obama said that the son he never had could have looked like Trayvon. He has not said the same about the dozens of young men shot down within blocks of his former Kenwood home.

Another particularly outrageous slur is the statement that “peaceful protest[ers]” are “dismissed” as troublemakers or paranoid. Check out the BLM-led protests in Ferguson, Atlanta, or Minnesota, which have been anything but peaceful. As for the rhetoric of BLM leaders, it is more than fair to characterize it as paranoid and intended to stir up trouble and strife–or worse. But since he insinuates that all protesters are peaceful, even when some are not, and that their complaints are valid, even when almost all are not, he absolves the violent and the provocateurs, and encourages the distortion of the truth.

Perhaps the worst line in the speech–again completely inappropriate in this setting–was this: “We flood communities with so many guns that it is easier for a teenager to buy a Glock than get his hands on a computer or even a book.”

Unpacking the mendacity of that statement would take many posts. A few things. First, just who is this “we”? I haven’t flooded guns anywhere: have you? This invocation of collective guilt (excluding himself, of course) is a common leftist trope. Second, it is patently absurd to say that it is easier for a teenager to get a Glock (starting price around $500) than a computer or a book. This is not an issue of availability or cost: it is an issue of choice. Third, and perhaps worst of all, is the denial of individual responsibility and moral agency to the “teenager” who chooses a gun over a book. But recognizing that would raise thorny and uncomfortable questions, when Obama’s purpose is to push easy nostrums (namely, gun control) and to condemn Americans and American institutions.

This is not a matter of mere rhetoric. There is a short distance between words, especially a president’s words, and especially a black president’s words on a racially charged matter, and actions. An extremely dangerous dynamic is at play, and incredible care is needed to avoid accelerating it.

Micah Johnson targeted police because of his belief that they target black men. In the day after the Dallas atrocity, police officers in Missouri, Tennessee, and Georgia were targeted. When police are targeted (and this has been a concern of police since Ferguson, and events in Baltimore) they are more likely to perceive a threat and shoot in response, which creates another cause célèbre which inflames the likes of Micah Johnson. And on and on it goes.

By repeating and embracing crucial elements of the fundamentally dishonest BLM narrative, Obama validates the aggrieved, and aggravates the dynamic. When a Sister Souljah moment is needed, Obama instead enables latter day Sister Souljahs–and worse.

So what is to be done? Honesty, and the avoidance of inflammatory fractional truths, would be a start.

So would be a full-throated condemnation of BLM and a concerted effort to marginalize it and to empower more responsible voices.

But I hold out little hope that Obama will do these things. He has already made plain his allegiances.

Indeed, he made them even more abundantly clear today: rather than condemning BLM, he is embracing it. The day after the memorial service in Dallas, he hosted BLM organizer Deray McKesson at the White House for a private meeting for three hours. (How many  people does Obama meet with privately for three hours? In his own cabinet, even?) (McKesson called the meeting a “convening.” What the hell is a convening? It’s not a noun!)

To meet with McKesson any time would be bad, but to do so the day after speaking at a memorial service for five police officers murdered by  a man who had told Dallas police negotiators that he was “upset by Black Lives Matter,” is beyond appalling. Step back for a minute and think about this. The day after turning a speech intended to honor slain policemen into another of his dreary lectures on America’s inveterate racism, he confers with the leader of an organization dedicated to the proposition that law enforcement routinely oppresses and assassinates African Americans.

Back in the ’60s, the refrain was “which side are you on?” We know exactly which side Obama is on.

It is deliberate, and it is a signal. And what it signals is that rather than using the power of his office to push back against an inflammatory movement that is in the midst of ramping up confrontations (with demonstrations planned in 37 cities on Friday), he is putting his power and authority behind that movement. Again, rather than pouring oil on troubled waters, throwing fuel on the fire. It is beyond disturbing.

What can others do? Perhaps the most practical and feasible step would be to enhance the credibility of investigations of law enforcement officers who employ deadly force, and to punish officers who employ it unjustifiably. This does not mean whitewashing police conduct–the exact opposite. Officers acting reasonably will prevail even searching investigations. But at the same time, it does mean that concerted efforts must be taken to de-politicize these investigations and cases. When major political figures (not just Obama, but Minnesota governor Dayton or the mayor of Baltimore) express their opinions on these police shootings, especially when the gun smoke still hangs in the air and the facts are not known, justice cannot prevail, and the credibility of the process is undermined. Demagogues like BLM exploit such doubts about process to fuel conflict.

The only margin I can see on which it is practically possible to reduce the frequency of confrontational interactions between police and African Americans in particular is the drug laws. This is obviously a complex and fraught subject, but criminalization of drugs clearly is a major reason for hostile interactions between police and people of all races, but African Americans in particular. It also contributes to violent criminality in minority communities most notably. The War on Drugs is problematic to say the least, and one of its most problematic aspects is how it exacerbates tensions between minorities and law enforcement. This is a good reason to rethink how it is fought, and whether it is worth fighting at all.

But that isn’t going to happen overnight, and maybe not ever. In the meantime, perhaps the best that can be achieved is “first, do no harm.” Unfortunately, a president in the best position to do good cannot muster even that.

 

 

 

 

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July 6, 2016

Brexit: Breaking the Cartel of Nations. Could Position Limits Be a Harbinger?

Filed under: Clearing,Commodities,Derivatives,Economics,Politics,Regulation — The Professor @ 7:50 pm

One of the ideas that I floated in my first post-Brexit post was that freed from some of the EU’s zanier regulations, it could compete by offering a saner regulatory environment. One of the specific examples I gave was position limits, for as bad as the US position limit proposal is, it pales in comparison to the awfulness of the EU version. And lo and behold! Position limits are first on the list of things to be trimmed, and the FCA appears to be on board with this:

Britain-based commodity exchanges may have some leeway in the way they manage large positions after the UK exits the European Union, but they will still have to comply with EU rules from 2018, experts say.

Position limits, a way of controlling how much of an individual commodity trading firms can hold, are being introduced for the first time in the Markets in Financial Instruments Directive II (MiFID II) from January 2018.

Britain voted to leave the EU last month, but its exit has to be negotiated with the remaining 27 members, a process that is meant to be completed within two years of triggering a formal legal process.

“It is too early to say what any new UK regime will look like particularly given pressure for equivalence,” James Maycock, a director at KPMG, said, referring to companies having to prove that rules in their home countries are equivalent to those in the EU.

“But UK commodity trading venues may have more flexibility in setting position limits if they are not subject to MiFID II.”

. . . .

Britain’s Financial Conduct Authority (FCA) said in a statement after the Brexit vote that firms should continue to prepare for EU rules. But it has previously expressed doubts about position limits on all commodity contracts.

“We do not believe that it is necessary, as MiFID II requires, to have position limits for every single one of the hundreds of commodity derivatives contracts traded in Europe. Including the least significant,” said Tracey McDermott, former acting chief executive at the FCA in February this year.

“And I know there are concerns, frankly, that the practical details of position reporting were not adequately thought through in the negotiations on the framework legislation.”

Here’s hoping.

This could explain a major driver behind the Eurogarchs intense umbrage at Brexit. Competition from the UK, particularly in the financial sector, will provide a serious brake on some of the EU’s more dirigiste endeavors. This is especially true in financial/capital markets because capital is extremely mobile. Further, I conjecture that Europe needs The City more than The City needs Europe. Hollande and others in Europe are talking about walling off the EU’s financial markets from perfidious Albion, but the most likely outcome of this is to create a continental financial ghetto or gulag, A Prison of Banks.

If financial protectionism of the type Hollande et al dream of could work, French, German and Dutch bankers should be dancing jigs right now. But they seem to be the most despondent and outraged at Brexit.

A (somewhat tangential) remark. Another reason for taking umbrage is that the UK has served as a safety valve for European workers looking to escape the dysfunctional continental labor markets. This is especially true for many younger, high skill/high education French, Germans, etc. (especially the French). With the safety valve cut off, there will be more angry people putting pressure on European governments.

This could be a good thing, if it forces the Euros (especially the French) to loosen up their growth-and-employment-sapping labor laws. But in the short to medium term, it means more political ferment, which the Euro elite doesn’t like one bit.

This all leads to a broader point. Cooperation is a double edged sword. The EU’s main selling point is that intra-European cooperation has led to a reduction in trade barriers that has increased competition in European goods markets. But the EU has also functioned as a Cartel of Nations that has restricted competition on many dimensions.

I note that one major international cooperative effort spearheaded by the Europeans is the attempt to reduce and perhaps eliminate competition between nations on tax. “Tax harmonization” sounds so Zen, but it really means cutting off any means of escape from the depredations of the state. But tax is just one area where governments don’t like to compete with one another. Much regulatory harmonization and coordination and imposed uniformity is intended to reduce inter-state competition that limits the ability of governments to redistribute rents.

This is one reason to believe that Britain’s exit will have some big upsides, not just for the UK but for Europe generally. It will invigorate competition between jurisdictions that statists hate. And it is precisely these upsides which send the dirigistes into paroxysms of anger and despair. Feel their pain, and rejoice in it.

 

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June 30, 2016

Financial Network Topology and Women of System: A Dangerous Combination

Filed under: Clearing,Derivatives,Economics,Financial crisis,Politics,Regulation — The Professor @ 7:43 pm

Here’s a nice article by Robert Henderson in the science magazine Nautilus which poses the question: “Can topology prevent the next financial crisis?” My short answer: No.  A longer answer–which I sketch out below–is that a belief that it can is positively dangerous.

The idea behind applying topology to the financial system is that financial firms are interconnected in a network, and these connections can be represented in a network graph that can be studied. At least theoretically, if you model the network formally, you can learn its properties–e.g., how stable is it? will it survive certain shocks?–and perhaps figure out how to make the network better.

Practically, however, this is an illustration of the maxim that a little bit of knowledge is a dangerous thing.

Most network modeling has focused on counterparty credit connections between financial market participants. This research has attempted to quantify these connections and graph the network, and ascertain how the network responds to certain shocks (e.g., the bankruptcy of a particular node), and how a reconfigured network would respond to these shocks.

There are many problems with this. One major problem–which I’ve been on about for years, and which I am quoted about in the Nautilus piece–is that counterparty credit exposure is only one type of many connections in the financial network: liquidity is another source of interconnection. Furthermore, these network models typically ignore the nature of the connections between nodes. In the real world, nodes can be tightly coupled or loosely coupled. The stability features of tightly and loosely connected networks can be very different even if their topologies are identical.

As a practical example, not only does mandatory clearing change the topology of a network, it also changes the tightness of the coupling through the imposition of rigid variation margining. Tighter coupling can change the probability of the failure of connections, and the circumstances under which these failures occur.

Another problem is that models frequently leave out some participants. As another practical example, network models of derivatives markets include the major derivatives counterparties, and find that netting reduces the likelihood of a cascade of defaults within that network. But netting achieves this by redistributing the losses to other parties who are not explicitly modeled. As a result, the model is incomplete, and gives an incomplete understanding of the full effects of netting.

Thus, any network model is inherently a very partial one, and is therefore likely to be a very poor guide to understanding the network in all its complexity.

The limitations of network models of financial markets remind me of the satirical novel Flatland, where the inhabitants of Pointland, Lineland, and Flatland are flummoxed by higher-dimensional objects. A square finds it impossible to conceptualize a sphere, because he only observes the circular section as it passes through his plane. But in financial markets the problem is much greater because the dimensionality is immense, the objects are not regular and unchanging (like spheres) but irregular and constantly changing on many dimensions and time scales (e.g., nodes enter and exit or combine, nodes can expand or contract, and the connections between them change minute to minute).

This means that although network graphs may help us better understand certain aspects of financial markets, they are laughably limited as a guide to policy aimed at reengineering the network.

But frighteningly, the Nautilus article starts out with a story of Janet Yellen comparing a network graph of the uncleared CDS market (analogized to a tangle of yarn) with a much simpler graph of a hypothetical cleared market. Yellen thought it was self-evident that the simple cleared market was superior:

Yellen took issue with her ball of yarn’s tangles. If the CDS network were reconfigured to a hub-and-spoke shape, Yellen said, it would be safer—and this has been, in fact, one thrust of post-crisis financial regulation. The efficiency and simplicity of Kevin Bacon and Lowe’s Hardware is being imposed on global derivative trading.

 

God help us.

Rather than rushing to judgment, a la Janet, I would ask: “why did the network form in this way?” I understand perfectly that there is unlikely to be an invisible hand theorem for networks, whereby the independent and self-interested actions of actors results in a Pareto optimal configuration. There are feedbacks and spillovers and non-linearities. As a result, the concavity that drives the welfare theorems is notably absent. An Olympian economist is sure to identify “market failure,” and be mightily displeased.

But still, there is optimizing behavior going on, and connections are formed and nodes enter and exit and grow and shrink in response to profit signals that are likely to reflect costs and benefits, albeit imperfectly. Before rushing in to change the network, I’d like to understand much better why it came to be the way it is.

We have only rudimentary understanding of how network configurations develop. Yes, models that specify simple rules of interaction between nodes can be simulated to produce networks that differ substantially from random networks. These models can generate features like the small world property. But it is a giant leap to go from that, to understanding something as huge, complex, and dynamic as a financial system. This is especially true given that there are adjustment costs that give rise to hysteresis and path-dependence, as well as shocks that give rise to changes.

Further, let’s say that the Olympian economist Yanet Jellen establishes that the existing network is inefficient according to some criterion (not that I would even be able to specify that criterion, but work with me here). What policy could she adopt that would improve the performance of the network, let alone make it optimal?

The very features–feedbacks, spillovers, non-linearities–that can create suboptimality  also make it virtually impossible to know how any intervention will affect that network, for better or worse, under the myriad possible states in which that network must operate.  Networks are complex and emergent and non-linear. Changes to one part of the network (or changes to the the way that agents who interact to create the network must behave and interact) can have impossible to predict effects throughout the entire network. Small interventions can lead to big changes, but which ones? Who knows? No one can say “if I change X, the network configuration will change to Y.” I would submit that it is impossible even to determine the probability distribution of configurations that arise in response to policy X.

In the language of the Nautilus article, it is delusional to think that simplicity can be “imposed on” a complex system like the financial market. The network has its own emergent logic, which passeth all understanding. The network will respond in a complex way to the command to simplify, and the outcome is unlikely to be the simple one desired by the policymaker.

In natural systems, there are examples where eliminating or adding a single species may have little effect on the network of interactions in the food web. Eliminating one species may just open a niche that is quickly filled by another species that does pretty much the same thing as the species that has disappeared. But eliminating a single species can also lead to a radical change in the food web, and perhaps its complete collapse, due to the very complex interactions between species.

There are similar effects in a financial system. Let’s say that Yanet decides that in the existing network there is too much credit extended between nodes by uncollateralized derivatives contracts: the credit connections could result in cascading failures if one big node goes bankrupt. So she bans such credit. But the credit was performing some function that was individually beneficial for the nodes in the network. Eliminating this one kind of credit creates a niche that other kinds of credit could fill, and profit-motivated agents have the incentive to try to create it, so a substitute fills the vacated niche. The end result: the network doesn’t change much, the amount of credit and its basic features don’t change much, and the performance of the network doesn’t change much.

But it could be that the substitute forms of credit, or the means used to eliminate the disfavored form of credit (e.g., requiring clearing of derivatives), fundamentally change the network in ways that affect its performance, or at least can do so in some states of the world. For example, it make the network more tightly coupled, and therefore more vulnerable to precipitous failure.

The simple fact is that anybody who thinks they know what is going to happen is dangerous, because they are messing with something that is very powerful that they don’t even remotely understand, or understand how it will change in response to meddling.

Hayek famously said “the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” Tragically, too many (and arguably a large majority of) economists are the very antithesis of what Hayek says that they should be. They imagine themselves to be designers, and believe they know much more than they really do.

Janet Yellen is just one example, a particularly frightening one given that she has considerable power to implement the designs she imagines. Rather than being the Hayekian economist putting the brake on ham-fisted interventions into poorly understood symptoms, she is far closer to Adam Smith’s “Man of System”:

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

When there are Men (or Women!) of System about, and the political system gives them free rein, analytical tools like topology can be positively dangerous. They make some (unjustifiably) wise in their own conceit, and give rise to dreams of Systems that they attempt to implement, when in fact their knowledge is shockingly superficial, and implementing their Systems is likely to create the highest degree of disorder.

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June 29, 2016

Will the EU Cut Off Its Nose to Spite Its Face on Clearing, Banking & Finance?

Filed under: Clearing,Commodities,Derivatives,Economics,Exchanges,Politics,Regulation — The Professor @ 7:45 pm

French President Francois Hollande is demanding that clearing of Euro derivatives take place in the Eurozone. Last year the European Central Bank had attempted to require this, claiming that it could not be expected to provide liquidity to a non-Eurozone CCP like London-based LCH.

The ECB lost that case in a European court, but now sees an opportunity to prevail post-Brexit, when London will be not just non-Eurozone, but non-EU. Hollande is cheerleading that effort.

It is rather remarkable to see the ECB, which was only able to rescue European banks desperate for dollar funding during the crisis because of the provision of $300 billion in swap lines from the Fed, claiming that it can’t supply € liquidity to a non-Eurozone entity. How about swap lines with the BoE, which could then provide support to LCH if necessary. Or is the ECB all take, and no give?

Hollande (and other Europeans) are likely acting partly out of protectionist motives, to steal business for continental entities from London (and perhaps the US). But Hollande was also quite upfront about the punitive, retaliatory, and exemplary nature of this move:

“The City, which thanks to the EU, was able to handle clearing operations for the eurozone, will not be able to do them,” he said. “It can serve as an example for those who seek the end of Europe . . . It can serve as a lesson.” [Emphasis added.]

That will teach perfidious Albion for daring to leave the EU! Anyone else harboring such thoughts, take note!

The FT article does not indicate the location of M. Hollande’s nose, for he obviously just cut it off to spite his face.

In a more serious vein, this is no doubt part of the posturing that we will see ad nauseum in the next two plus years while the terms of the UK’s departure are negotiated. Stock up with supplies, because this is going to take a while, since (1) everything is negotiable, (2) almost all negotiations go to the brink of the deadline, or beyond, and (3) these negotiations will be particularly complicated because the Eurogarchs will be conducting them with an eye on how the outcome affects the calculations of other EU members contemplating following Britain out the door–and because immigration issues will loom over the negotiations.

When evaluating a negotiation, it’s best to start with the optimal, surplus maximizing “Coasean bargain” (a term which Coase actually didn’t like, but it is widely used). This, as Elon Musk would say, is a no brainer: allow € clearing in London, through LCH. That is, a maintenance of the status quo.

What are the alternatives? One would be that € clearing for those subject to EU regulation and some non-EU firms would take place in the Eurozone (say Paris or Frankfurt), some € clearing might take place in London or the US, and most dollar and other non-€ clearing would take place in London and the US.  This would require the EU to permit its banks to clear economically in the UK or US, by granting equivalence to non-EU CCPs for non-€ trades, or something similar.

There are several inefficiencies here. First, it would fragment netting sets and increase the probability that one CCP goes bust. For instance, if a bank that is a member of an EU and a non-EU CCP (as would almost certainly be the case of the large European banks that do business in all major currencies) defaulted, it is possible that it could have a loss on its € deals and a gain on its non-€ deals (or vice versa). If those were cleared in a single CCP, the gain and loss could be offset, thereby reducing the CCP’s loss, and perhaps resulting in no loss to the CCP at all: this is what happened with Lehman at the CME, where losses on some of its positions were greater than collateral, but losses on others were smaller, and the total loss was less than total collateral. However, if the business was split, one of the CCPs could suffer a loss that could potentially put it in jeopardy, or force members to stump up additional contributions to the default fund during a time when they are financially stressed.

Second, default management would be more difficult, risky and costly if split across two or more CCPs. It would be easier to put in place dirty hedges for a broader portfolio than two narrower ones, and to allocate or auction off a combined portfolio than fragmented ones. Moreover, it would be necessary to coordinate default management across CCPs in a situation where their interests are not completely aligned, and indeed, where interests may be strongly in conflict. Furthermore, there would be duplication of personnel, as CCP members would be required to dispatch people to two different CCPs to manage the default.

Third, even during “peacetime,” fragmented clearing would sacrifice collateral and capital efficiencies and increase operational costs and complexity.

But it could be worse! Maybe the Europeans will cut off their noses and ears (and maybe some other parts lower down), and deny a UK CCP equivalence for any transaction undertaken by an EU bank. The outcome would be EU banks clearing in Europe, and most everybody else clearing outside of Europe. This would result in multiple inefficiently small CCPs clearing in all currencies that would exacerbate all of the negative consequences just outlined: netting set inefficiencies would be even worse, default risk management even more difficult, and peacetime collateral, capital, and operational efficiencies would be even worse.

Oh, and this alternative would require the ECB to obtain dollar and sterling (and other currency) liquidity lines to allow it to provide non-€ liquidity to its precious little CCP. How hypocritical is that? (Not that hypocrisy would cost Hollande et al any sleep. It hasn’t yet.)

The fact is that CCPs exhibit strong economies of scale and scope, and although mega-CCPs concentrate risk, fragmentation creates its own special problems.

So the wealth-maximizing outcome would be for the EU to come to an accommodation on central clearing that would effectively perpetuate the pre-Brexit status quo. Wealth maximization exercises a strong pull, meaning that this is the most likely outcome, although there will likely be a lot of posturing, bluffing, threatening, etc., before this outcome is achieved (and at the last minute).

I would expect that EU banks would support the Coasean bargain, further increasing its political viability. Yes, Deutsche Borse would be pushing for a EU-centric outcome, and some Europols would take pride at having their own (sub-scale and/or sub-scope) CCP, but the greater cost and risk imposed on banks would almost certainly induce them to put heavy pressure behind a status quo-preserving deal.

This raises the issue of negotiation of banking and capital market issues more generally. There has been a lot of attention paid to the fact that British banks would probably lose passporting rights into the EU post-exit, and this would be costly for them. But European banks actually rely even more on passporting to get access to London. Since London is still almost certain to remain the dominant financial center (especially since the UK government will have a tremendous incentive to facilitate that), European banks would suffer as much or more than UK ones if the passporting system was eliminated (and a close substitute was not created).

Thus, if the negotiations were only about clearing, banking, and capital markets, mutual self-interest (and political economy, given the huge influence of the finance sector on policymakers) would strongly favor a deal that would largely maintain the status quo. But of course the negotiations are not about these issues alone. As I’ve already noted, the EU may try to punish the British even if it also takes a hit because of the effect this might have on the calculations of others who might bolt from the Union.

Furthermore, the most contentious issue–immigration–is very much in play. Merkel, Hollande, and others have said that to obtain a Norway-style relationship with the EU, the UK would have to agree to unlimited movement of people. But that issue is the one that drove the Leave vote, and agreeing to this would be viewed as a gutting of the referendum, and a betrayal. It will be hard for the UK to agree to that.

Perhaps even this could be finessed if the EU secured its borders, but Merkel’s insanity on this issue (and the insanity of other Eurogarchs) makes this unlikely, short of a populist political explosion within the EU. But if that happens, negotiations between the EU and the UK will likely be moot, because there won’t be much of the EU left to negotiate with, or worth negotiating with.

In sum, if it were only about banking and clearing, economic self-interest would lead all parties to avoid mutually destructive protectionism in these areas. But highly emotional issues, political power, and personal pride are also present, and in spades. Thus, I am reluctant to bet much on the consummation of the economically efficient deal on financial issues. The financial sector is just one bargaining chip in a very big game.

 

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June 27, 2016

MOAR! Europe

Filed under: Economics,Politics,Regulation — The Professor @ 9:30 pm

In my first Brexit post I wrote:

European leaders–Merkel most notably–are fond of saying “More Europe,” meaning more centralization and more suppression of local control. If they want Europe to survive as a political entity, they need to reverse their mantra to “Less Europe.” They need to reverse the creation of a hyper-state. They need to be more respectful of local, national sentiments and differences. Brexit shows that if they fail to do so, they are running the serious risk of having no “Europe” at all.

Are they heeding the lesson? Early signs suggest no. So be it. They are reaping what they sowed, and if they decide to sow more, so shall they reap.

The first day of the first post-Brexit week brought reports that the Euros are indeed doubling down, and moving to MOAR! Europe. From the (rabidly pro-Remain) FT:

The German, French and Italian also called for a “new impulse” to revitalise the EU. They are considering common EU-wide initiatives in security, external border control, antiterrorism measures, and in boosting economic growth and employment. Recognising the disenchantment of many young Europeans with politics, they pledged to focus on youth-oriented proposals, such as educational exchanges. “We must not simply wait for what happens. We know that must not waste a single minute,” Mr Renzi said.

Two less posh (and anti-EU) publications filled in some details. I don’t vouch for the reliability, but they do jibe with the “new impulse” theme:

The foreign ministers of France and Germany are due to reveal a blueprint to effectively do away with individual member states in what is being described as an “ultimatum”.

Under the radical proposals EU countries will lose the right to have their own army, criminal law, taxation system or central bank, with all those powers being transferred to Brussels.

The public broadcaster reports that the bombshell proposal will be presented to a meeting of the Visegrad group of countries – made up of Poland, the Czech Republic, Hungary and Slovakia – by German Foreign Minister Frank-Walter Steinmeier later today.

Excerpts of the nine-page report were published today as the leaders of Germany, France and Italy met in Berlin for Brexit crisis talks.

In the preamble to the text the two ministers write: “Our countries share a common destiny and a common set of values that give rise to an even closer union between our citizens. We will therefore strive for a political union in Europe and invite the next [other?] Europeans to participate in this venture.”

“Invite the next Europeans to participate in this venture.” Not too Orwellian, eh? Sounds like Don Corleone making an offer they can’t refuse. No RVSP necessary.

This would throw down the gauntlet to tens (and likely hundreds) of millions of Europeans who might prefer to decline the invite, thank you very much.

It brings to mind Eisenhower’s dictum: If a problem cannot be solved, expand it. By spurning the lessons of Brexit, the Eurogarchs are either going to succeed in jamming their vision down the throats of 500 million people (435 million, excluding the UK) or bring down the entire edifice trying.

And have no doubt, these “leaders” (“drivers” would be more apt) will not let anything as trivial as widespread popular opposition deter them. Consider the president of the European Parliament, Martin (“Don’t Call Me Sergeant“) Schulz:

Screen Shot 2016-06-27 at 10.04.10 PM

Clearly a gaffe by Herr Schulz: he spoke the truth. The EU philosophy is profoundly anti-democratic.

Good luck with your Fourth Reich, Marty. The first three worked out so swell.

European Union president Jean-Claude Juncker, widely blamed by eastern Europeans in particular for Brexit, has taken a similarly hard line:

Jean-Claude Juncker said on Friday: “The repercussions of the British referendum could quickly put a stop to such crass rabble-rousing, as it should soon become clear that the UK was better off inside the EU.” Britain simply has to go, on bad terms, pour encourager les autres.

“Take that, you crass rabble rousers! And to show how mad I am, I won’t speak English.”

Juncker is also supposedly about to announce a plan to force the eight EU states that are not on the Euro (e.g., Denmark, Bulgaria, and Sweden) into the Eurozone. More doubling down.

(As an aside, Juncker is a notorious drunk–it is common knowledge that it is hopeless to do business with him after 3PM, because he’ll be sloshed–and Schulz is also an alcoholic. You’re in the best of hands, Europe!)

And what will they get if they succeed in achieving their goal of a Leviathan that swallows 27 states? A perpetuation of economic stagnation due to excessive, pervasive, and absurd regulation often adopted in the name of grandiose goals. Here’s an illustration of how absurd:

The EU is poised to ban high-powered appliances such as kettles, toasters, hair-dryers within months of Britain’s referendum vote, despite senior officials admitting the plan has brought them “ridicule”.

The European Commission plans to unveil long-delayed ‘ecodesign’ restrictions on small household appliances [like kettles and vacuum cleaners] in the autumn. They are expected to ban the most energy-inefficient devices from sale in order to cut carbon emissions.

Not a sparrow falls . . .

And pray tell just how many thousandths of a degree would this shave off global temperatures? Who cares? This is virtue signaling in jackboots. Here’s the best part:

At the meeting, Jyrki Katainen, the Commission’s vice president for growth, said they should push ahead with the plans for standardised energy usage limits as they could contribute significantly to emissions targets.

The “vice president for growth.” How Orwellian is that? This is a pitch perfect example of the anti-growth effects of EU policy.

This strategy of expanding the problem will increase and perpetuate the geopolitical risk that has shaken the markets. It will intensify a confrontation between elitist and populist forces in Europe, with unpredictable results. I don’t know how it will end, exactly, except that it is unlikely to end well.

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June 26, 2016

Brexit: A Case Study in Preference Falsification

Filed under: Economics,History,Politics — The Professor @ 6:23 pm

About 20 years ago Timur Kuran wrote Private Truth, Public Lies. The book introduces the concept of preference falsification, whereby social pressure induces people to make public statements that are contrary to their private beliefs or preferences.

Preference falsification helps explain why revolutions, especially in totalitarian countries, or in oligarchic societies with substantial hierarchical social control, seem to come from like a bolt from the blue. Because of preference falsification, widespread dissatisfaction is concealed. In response to some shock–which can be very minor–people reveal their dissatisfaction or anger simultaneously, resulting in a revolt or civil unrest.

There is a coordination game aspect to the transition between passivity and revolt. People will reveal their preference by going into the street only when they are convinced that enough other people share their views. Widespread falsification makes it difficult to know how widespread the dissatisfaction is, and tends to cause people to remain quiet and at home. But if something triggers enough people to reveal it, a cascade is triggered and the equilibrium flips from no one revealing to everyone revealing.

In the UK, it is clear that numerous individuals were concealing their true preferences about Leave vs. Remain. The elite in the UK, and the EU as a whole, mounted a campaign of insult and intimidation. They had no positive message, but engaged in fear-mongering and ad hominem. Any brave soul who put his or her head above the parapet was immediately subjected to a barrage of invective. So many people stayed hunkered down, and concealed their preferences.

Social control worked, in one sense: it kept people’s mouths shut. But unlike the revolutionary situation, there was no coordination problem, and no need for a spontaneous and simultaneous recognition that the socially ostracized beliefs were in fact widely shared in order to spark action. The Referendum allowed people to express their preferences privately, and to keep them private if they chose. People felt compelled to stifle expression of their preferences in public, but could do so in a way that did not expose them personally to obloquy if they chose not to reveal their vote. They didn’t have to coordinate, which is the main impediment to translating dissatisfaction into action. The Referendum made it easy.

Although the mechanism was somewhat different, the result was the same: an outcome that completely shocked the elite at the top of the social and power hierarchy.

Indeed, I would say that the attempt to exert social control actually affected preferences. The bullying and scorn and insult from the Remain crowd revealed a lot about who they are and what they think of those who are not them. I think it is highly likely that many who might have actually been favorably disposed to the Remain side looked at that and said: “Are these the kind of people I want running my life? Hell No!”

The unfalsification of preferences that the vote allowed is why its effect was so cataclysmic. The smug priors of the better-than set were hit by an avalanche of information about preferences. Their confidence in their popularity, and in the shared belief in their superiority, has been shattered. They now have to update their beliefs about their popularity and standing in the rest of the EU.

In a sense, the British have done the Eurogarchs a favor, by giving them a big dose of reality that should shake them from their reveries. They have time to absorb this information and adjust course.

I predict that they will not. The initial reaction–doubling down on the scorn–is a pretty good indication of that. Furthermore, they seem to be finding all sorts of ways to rationalize the outcome, and suggest that it was a one-off that reflected English (and Welsh) eccentricity.

Good luck with that.

Now the Eurogarchs are confronted with a rather daunting choice. Do they risk referenda (or other means of expressing popular preferences about the EU and its current course) in other countries? That would reduce the cost of revealing true preferences, and risk a Brexit-like outcome. But if they refuse to countenance democratic means of preference expression, the preference revelation could come in a much more destructive and violent way, through civil unrest or outright rebellion.

Societies that rely heavily on social control to induce uniformity in the expression of opinion are inherently brittle. They tend to be tidier and more orderly than societies that don’t, but more expression-tolerant societies provide means for people to blow off steam, and more importantly, to give those in government information that can induce them to change course before alienation becomes too extreme. This makes the tidy, orderly, tightly controlled societies more vulnerable to sudden and severe breakdown.

The great cultural, linguistic, and economic heterogeneity of the EU means that greater pressure is required to create homogeneity in expressions of opinion about political issues. Even greater pressure is needed when there is a big shock that raises questions about the competence of the leadership, and its consideration for the opinions of those they rule. Europe has experienced two big shocks–economic malaise, and perhaps more importantly, the refugee crisis.

This means that the EU is particularly vulnerable to preference falsification at present. It is also acutely vulnerable to a shattering of its brittle structure when those preferences are revealed. For this reason, I would say that the expectation should be that the EU will muddle through, but there is a substantial tail risk that it will shatter into 28 pieces. And when it does, it will not go with a whimper, but a bang.

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June 25, 2016

Brexit: Epater les Eurogarchs

Confounding all elite prognostication (more on this aspect below), British voters repudiated their self-anointed better-thans and voted to leave the EU.

Market reaction was swift and brutal. The pound sold off dramatically, as did UK stocks. Interestingly, though, Continental stock markets fell substantially more. Bank stocks took the brunt. Volatility indices spiked. Oil was down modestly.

These reactions were not due, in my view, to the direct effect of a British exit from the EU, via conventional channels (e.g., increased costs of trade resulting in inefficiencies and a decline in productivity due to failure to exploit comparative advantage, resulting in a decline in incomes). Instead, they reflect a substantial increase in risk, and in particular geopolitical risk. The unexpected result increases substantially the odds of a falling apart of the EU–or at the very least, of it losing quite a few of its parts. That’s why German, French, and Dutch markets sold off more than the UK.

I was in Denmark last month, speaking to shipowners. Several said that if the UK were to leave the EU, Denmark is likely to go as well: since Denmark is not on the Euro, it is easier for it to leave than Eurozone nations, and the Danes have had their fill of European immigration policy, among other things.

But there is now talk of core countries–including France–leaving. What’s more, the Brexit vote demonstrates the depth and intensity of populist, nationalist sentiment, something the elites had convinced themselves was a marginal force that could be contained by insulting it as racist and isolationist. That was tried in the UK, and failed spectacularly. Now everyone should be on notice that the smug, supercilious, and superior are sitting on a caldera.

It is this fear that the British departure creates a bad precedent that is leading some European leaders to advocate a punitive approach to negotiations with Britain. As a one-off, this makes no sense: a battle of trade barriers and regulations and red tape would harm continentals too. But if the Euros view this as a repeated game, punishment of the British to deter others from getting any notions in their heads about following their lead has some appeal.

But this is a finite game: there are only so many countries in Europe. The Euro threats make sense as a rational strategy only if there is some appreciably probability that the leadership is viewed as crazy, and will punish even when that is self-harming. Come to think of it . . .

As for the immediate effects, Brexit has the biggest potential to cause disruptions and inefficiencies in the financial sector, because of London’s dominance. Clearing is one example. How will LCH fit into the fragmented regulatory landscape? Recall the tortuous negotiations between the US and EU over recognizing each other’s CCPs. Will that have to be repeated between the UK and the EU, and under the clouds of recrimination and punishment strategies? As another example, MiFID II is scheduled to go into effect before Britain leaves. Will it be implemented, then changed? Post-exit British firms will no longer be subject to the regulatory and judicial bodies in charge of enforcing these regulations: how will they fill that breach?

Regardless of the specifics, there will inevitably be greater regulatory and legal fragmentation, and this will increase complexity and cost. But it also creates opportunities. The UK can now engage in regulatory competition with the EU (and the US), which is a different thing altogether from trying to influence regulatory policy from inside the tent (which Cameron attempted with a notable lack of success). This is constrained to some degree by supranational regulation (e.g., Basel), but London prospered quite well as a financial center post-War, pre-EU by offering regulatory advantages over the US and European countries. (Remember Eurodollars!) (One specific thought: would the UK proceed with something as inane and costly as the MiFID commodity position limits? Or applying CRD IV capital requirements on commodity traders? Since these initiatives were driven by the continentals, I seriously doubt it.)

This is all very complicated, and will be played out in the context of a larger game between Britain and the EU (and between the EU and individual EU countries). Hence the outcome is wholly unpredictable. But having Britain as an independent player will change dramatically the regulatory game. The greater competition is likely to result in less regulation, and crucially less stupid regulation. Further, even to the extent that one jurisdiction insists on stupid regulations (with the EU being the odds-on favorite here), the existence of competing jurisdictions means that many will be able to escape the stupidity.

As for the broader political lesson here, it is a decisive repudiation of a self-satisfied soi disant elite by the great unwashed. The EU has been neuralgic about democracy since its inception, and Brexit shows you exactly why their fears of it are justified. The people have spoken. The bastards. And the Euros will try mightily to make sure that never ever happens again.

There’s been a lot of commentary along these lines. Gerard Baker’s piece in the WSJ is probably the best I’ve read. This piece also from the WSJ is pretty good too.

This is a global phenomenon: the Trump insurgency in the US is another example. What is most disturbing–and most revealing–about the reaction of the elites to these outbursts of popular opposition to their direction and instruction is their lack of self-examination and humility, and their immediate resort to scorn and insult directed at those who had the temerity to defy them. Immediately after the results were clear, those voting leave were tarred as old/white/stupid/poor/uneducated/racist.

Totally lacking was the question: “If argument and evidence are so clearly on our side, why did we fail so miserably in convincing people of the obvious?” To these self-perceived elites, their superiority is self-evident and any opposition can only be attributed to mental defect or bad faith.

Not only is this superficial and immature–nay, juvenile and narcissistic–it is amazingly self-destructive. You were rejected because it was widely believed–with good reason–that you were aloof, condescending, and lacking in understanding of and empathy for the concerns of millions of people not of your social set. What better way to cement that reputation than by proceeding to piss all over those people? You think that will help them get their minds right, and vote for you next time? Think that, and you truly are delusional.

And mark well: this elite condescension is not heard just in the Midlands, but it comes through loud and clear in France, Germany, the Netherlands, and other countries in Europe. Consequently, this reaction actually increases the odds of an EU crisis. Those who refuse to respond constructively and thoughtfully to adverse feedback are likely to see things get worse, rather than better.

This condescension also helps explain the surprise at the Brexit outcome. So convinced of their virtue and intelligence, the Remain side could not comprehend that large numbers of people could take the opposite side. Secure in their bubble, talking only to one another, they had no idea of what was going on outside it. The Pauline Kael effect, with a British accent.

Further, the concerted effort in the establishment media to malign the Leavers succeeded in silencing many of them–but not in changing their minds. (Most disturbingly, the Remain side took strange comfort in the murder of Jo Cox.) They were bludgeoned into stubborn silence, which lulled the establishment into believing that the opposition was marginal and marginalized: this helps explain the pre-vote 90 percent betting odds on Remain, with the betting being dominated by those inside the bubble. But the silent bided their time and exacted their revenge.

Payback, as they say, is a bitch. But are the elites learning from this lesson? The first indications are negative.

The EU epitomizes what Thomas Sowell referred to as the Vision of the Anointed. This review summarizes the book of that title well, and although Sowell focuses on the US, what he said applies in spades to the EU, and Europhiles:

In The Vision of the Anointed, the distinguished economist and social theorist Thomas Sowell makes an important contribution to classical-liberal and conservative thought by scrutinizing the ways in which a self-consciously elite, or “anointed,” group uses ideas to maintain its power in American political life. Sowell regards American political discourse as dominated by people who are sure that they know what is good for society and who think that the good must be attained by expanded government action. This modern-liberal elite exerts its influence through institutions that live by words: the universities and public schools, the media, the liberal clergy, the bar and bench. Its dominance results from its command of the information that words convey and the attitudes that words inspire.

People who live by words should live also by arguments, butas Sowell richly documentsthe modern-liberal elite is not so good at arguing as it is at finding substitutes for argument. Sowell analyzes the major substitutes. Suppose that you doubt the necessity or usefulness of some great new government program. You may first be presented with a quantity of decontextualized “facts” and abused statistics, all indicating the existence of a “crisis” that only government can resolve. If you are not converted by this show of evidence, an attempt will probably be made to shift the viewpoint: outsiders may doubt that there is a crisis of, say, homelessness, but “spokesmen for the homeless” purportedly have no doubts.

. . . .

If even these methods fail to win you over, attention will be redirected from the political issue to your own failure of imagination or morality. It will be insinuated that people like you are simplistic or perversely opposed to change, lacking in compassion and allied with the “forces of greed.” (As Sowell observes, it is always the payers rather than the spenders of taxes who are considered vulnerable to the charge of greed.) [Emphasis added.]

The Anointed are a self-identified elite. They think that elite is a synonym for “meritorious,” “intelligent,” “wise,” or “morally superior.” But “elite” refers first and foremost to a place in a hierarchy, and the merit, intelligence, wisdom, and morality of those at the top of a hierarchy depends on the system. Hayek noted over 70 years ago that in a statist, crypto-socialist system the worst get to the top, i.e., the elite is a collection of the worst. The Eurogarchy shows just how right Hayek was.

For all the paeans sung to it, the EU has become far more than a means of reducing barriers to the flow of goods, capital, and people: that could have been accomplished with something as simple as the commerce clause to the US Constitution. Instead, the Anointed have constructed a vast hyper-state that controls and regulates every aspect of commercial activity, and much beyond. Cost raising and incentive sapping explicit restrictions on trade and investment across historical borders have been replaced by border-spanning onerous and minute regulations that raise costs and dull incentives: innovation has been especially hard hit. Moribund growth in the post-crisis EU should raise questions, but the Eurogarchs plunge ahead with their vast regulatory schemes.

I would approve of a supra-national organization that reduced the impediments to individuals consummating mutually beneficial bargains and exchanges. But that is not what the EU is. It is a dirigiste organization predicated on the belief that a technocratic elite knows better, and can direct and guide far more effectively than the invisible hand. Although its demise could lead to something worse, there are definitely better alternatives. Hence, the discomfort of the EU worshippers is music to my ears.

European leaders–Merkel most notably–are fond of saying “More Europe,” meaning more centralization and more suppression of local control. If they want Europe to survive as a political entity, they need to reverse their mantra to “Less Europe.” They need to reverse the creation of a hyper-state. They need to be more respectful of local, national sentiments and differences. Brexit shows that if they fail to do so, they are running the serious risk of having no “Europe” at all.

Are they heeding the lesson? Early signs suggest no. So be it. They are reaping what they sowed, and if they decide to sow more, so shall they reap.

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June 22, 2016

Sometimes Hooligans are Just Hooligans

Filed under: Politics,Russia,Sports — The Professor @ 8:12 pm

The UEFA Euro 2016 has seen the usual hooliganism. What would soccer–football, excuse me–be without it? (Isn’t it interesting how the “beautiful game” routinely sparks violence while a game denigrated for violence–American football–seldom does?)

Nothing new about that. What makes Euro 2016 somewhat unique is the focus on Russian hooligans, and the attribution of malign political motives to them, and most importantly, direction from the very top.

The English mixed it up with the Russians in Marseille, and got the worst of it. The English press was whinging about the unfairness of it all. Apparently, as opposed to being fat, drunken louts like proper English hooligans, the Russians were hard, sober toughs. That’s not cricket!

Englishman Tim Newman–whom I’m honored comments periodically here–was having none of it:

You’ve got to love the British press:

England fan fighting for his life and dozens more injured as English fans and Russian thugs clash at Euro 2016 in Marseille

The English were fans.  The Russians were thugs.  Presumably no Englishman in Marseille last night displayed thuggish behaviour, and no Russian showed the slightest interest in football.

. . . .

But what I never heard, in all my time in Phuket or indeed ever in my life, was a story told to me by non-Brit complaining of getting into a fight with another non-Brit.  For whatever reason, Frenchmen don’t seem to end up fighting Spaniards in beach resorts and Germans somehow manage to rub along all right with Italians on holiday without kicking the shit out of one another.  The common element in all the fighting in beach resorts across the world, particularly the Mediterranean, is the presence of young Brits.  Little surprise then that the only trouble seen thus far at the Euro 2016 tournament features the same demographic.

There were battles involving other nationalities pretty much everywhere matches were played. It’s what those oh-so-civilized Euros do.

It may well be true that the Russians were fitter, better trained, and more organized, and kicked ass as a result. It may well also be true that members of the Russian security forces and veterans of the Donbas were among the Ultras. But to claim that this is part of “Putin’s special war” is beyond idiotic.

One of the main pieces of “evidence” that have been trotted out to suggest official complicity are the Tweets of Duma deputy speaker Igor Lebedev: “I don’t see anything bad in the fans fighting. On the contrary, well done guys. Keep it up!” and “I don’t understand those politicians and bureaucrats who are now denouncing our fans. We need to defend them, and they’ll come home and we’ll sort it out.”

Deputy Speaker of the Duma. Sounds pretty official and important, right? Except that (a) the Duma is merely a Potemkin legislature, and (b) people like Lebedev (who is a member of Zhirinovsky’s party) are in the Duma precisely to provide an outlet for the nationalist loons: better to have them inside the Duma where they can be watched and controlled and do no harm, than out on the streets making trouble.

It’s actually embarrassing to cite someone like Lebedev as a barometer of official Kremlin (i.e., Putin) policy. It’s a case of those who are talking don’t know, and those who know aren’t talking.

And really, you have to pick a narrative. Those pushing the story that  Russian soccer hooligans are conducting special warfare in Europe also  portray Putin as a mastermind playing chess, and dominating ineffectual and overmatched European and American leadership. But these claims are almost impossible to reconcile.

At the very time that Europe is vacillating about maintaining sanctions against Russia, and there are deep divisions within Europe about whether to confront Russia more forcefully (moves that German FM Steinmeier called “saber rattling”), the soccer hooligans are an irritant in the Russian-European relationship. No, Putin is not about be all warm and fuzzy, but he has no reason to engage in provocations that alienate the German and French governments, but which produce no tactical or strategic benefit.

In the realm of sport in particular, this couldn’t come at a worse time. Russia’s reputation is already at rock bottom due to the doping scandal which has resulted in the banning of Russian track and field athletes from the Olympics, and could conceivably result in the barring of Russian participation from Rio altogether. Hardly an opportune time to cast Russian sportsmanship in an even worse light.

It would be incredibly short sighted and unproductive for Putin stoke soccer violence. What could he gain? Nothing that I can see. However, it is easy to see what it costs him: it increases the likelihood that sanctions will endure, and provides an argument for those advocating a more muscular approach to Russia.

Yes. Maybe Putin is that short-sighted and capable of cutting his nose to spite his face. But if that’s the case, he’s the antithesis of a strategic genius. He would be nothing more than a mouth-breathing numb-nuts like Lebedev.

Conversely, if  you choose the “Putin is a chess master” narrative, the Russian soccer thuggery suggests that the vaunted power vertical is not all encompassing, and that Putin does not exercise the complete control that is often attributed to him–perhaps not even over the security services. (His reorganization of those services supports this interpretation: why reorganize something that is completely at his beck and call?)

My take on all of this is that there are indeed a lot of obnoxious, violent Russians–just like there are a lot of obnoxious, violent Euros from any nation you care to name. Soccer hooliganism has become a Euro tradition, and the Russians are joining in: chalk it up to their integration into Europe! But as for broader political implications, if Russian soccer hooligans have official sanction, Putin isn’t very clever: indeed, he would have all the strategic acumen of the criminals in Fargo. And if they don’t have official sanction, Putin isn’t as omnipotent within Russia as he is widely portrayed.

Sometimes hooligans are just hooligans. Putin no doubt finds that hooligans have their political uses, but stirring trouble in Europe at such a fraught time isn’t one of them.

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