Streetwise Professor

February 8, 2011

There I Go Again

Filed under: Economics,Politics,Regulation — The Professor @ 8:35 pm

I know that more than a few of you get bent out of shape when I bash Obama.  Sorry, but there are times it just can’t be helped–and which it is justly deserved.

Like now, with regards to his two most recent signature economic initiatives: high speed rail and corporate social responsibility.

I mean, seriously.  If trains get you off, buy a Lionel and spare us subsidizing high speed rail to the tune of billions of dollars.  It’s economic insanity.

Don’t take my word for it.  Harvard’s Ed Glaeser has run the numbers, and they don’t add up.  Not even close.  Not even when you incorporate generous estimates of the environmental benefits.  Glaeser always make assumptions that err on the side of making rail look good, and it never does.

What’s more, I haven’t even seen anyone attempt to make the other standard argument for subsidies, namely, that there is some sort of information externality, arising from learning-by-doing, for instance.

Big government types need to get over their Edifice Complex, and stop deluding themselves that subsidizing the inefficient creates wealth.  And in most circumstances–including virtually all of those things like high speed rail, renewables (e.g., windmills and solar), electric autos, etc., that this administration pushes–the fact that something requires a subsidy to come into existence tells you it is a turkey.

Insofar as the corporate responsibility thing goes, Stephen Bainbridge does a brutal takedown based on transactions cost economics considerations.  But there are other equally good reasons to reject forcefully the corporate responsibility theme.  Most importantly, there is the Knowledge Problem.  Good intentions are not enough.  You need to have information.  Corporations that maximize shareholder value (or profits) respond to economic signals in the form of prices.  Prices summarize vast amounts of information about the value of resources in alternative uses, and in a profit-driven system provide an incentive to direct those resources to their highest valued use.  As that noted right wing radical Bertrand Russell said, efficiency is the highest form of altruism.  In striving for efficiency, using resources efficiently in the way prices direct, corporations are acting in a responsible, altruistic way–even if that is not their intent.

Prices and profits are signals that corporate managers and directors can understand and respond to.  Vapory concepts of “social responsibility” provide no real guide as to the costs and benefits of alternative actions.  This is just a concept that can be enlisted to advance political agendas, and to rationalize the direction of valuable resources to those making claims for them that cannot be justified based on economic calculation.  There is always an unlimited supply of people clamoring that they are truly deserving: how is it possible to choose between these competing–and collectively unachievable–demands?  It isn’t.  And it is pointless and wasteful to expect corporate managers and directors to do so, rather than do what they are capable of doing–directing resources to the highest value resources, as indicated by prices.

Sometimes prices are misleading, because of externalities, for instance–or because of government policies (e.g., tariffs, explicit and implicit subsidies).  But as Bainbridge says, there are other, more targeted ways to deal with those problems.  These include specific legislation, regulations, and the tort system.  All are imperfect–believe me, I know–but at least there are procedural checks and balances that force some attempt to justify the benefits and costs, and provide an opportunity for others to challenge these claims.  In contrast, imposing some sort of vague duty on corporate officers to “do good” is subject to no such checks.  Some may try to do good, but may do ill instead because they lack the incentive or information to do real good.  Others may use “social responsibility” to indulge their own preferences while imposing great costs on others whose resources they utilize in the cause.

But more ominously, creating a presumption that corporations have some broader social responsibility subjects them to political pressure, often verging on blackmail and at times crossing over that line.  It effectively subordinates corporations–and hence their living, breathing shareholders, for those who recoil at the idea of assigning personhood to a corporation–to politicians who arrogate to themselves the role of speaking in the public–“social”–interest.  This is exactly why the idea is catnip to progressives like Obama.  They don’t like government power constrained by Constitutional and procedural checks and limits.  They don’t like limits on their discretion.  Passing laws or imposing regulations that are subject to legal challenge are a lot harder than executing a shakedown.  Once corporate executives concede that their responsibility is not limited to maximizing shareholder value, they become political puppets always vulnerable to such shakedowns.  There are always competing claims on corporate resources, and political entrepreneurs more than willing to exert those claims.

If you want to see extreme examples of how this works, look at Chavez in Venezuela, or Putin, both of whom browbeat corporations and investors to direct resources to their pet causes in the name of “social” objectives.  And no, I’m not saying Obama=Chavez.  I’m only saying that looking at something in its most purified or extreme forms is often the best way of identifying the essential principle.

The corporate responsibility movement is just another flavor of corporatism.  A conscription of private resources to achieve political (and usually redistributive) objectives, but without the procedural hurdles that constrain such conscription via legislation, regulation, or adjudication.  Which is exactly why progressives like Obama find it so attractive.

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  1. This gets to the basic discussion Americans have avoided for decades – Exactly what is the role of government?

    Progressives have long seen life as a series of problems to be solved by government. Hence, government control of the key drivers of society is something coveted bt left leaning politicians. By gaining control of as much of society as possible, left leaning politicians control the means necessary to solve the problems of the people by engineering a more social and “just” society. Sadly, we have all learned how misguided such an approach can be. When Obama decreed his wish was to “redistribute the wealth” he sought not to increase the wealth of the nation and empower individuals to enjoy more productive and prosperous lives. Rather, he set forth that his goal was to confiscate the property of one class of people and (after taking a small percentage to fund the mechanisms needed to effect the redistribution) transfer the confiscated wealth to a class of politically favored individuals to spend as they please. Instead of making all Americans better off, his plan left the productive class deprives of property, fed the inefficiencies of government and left others still dependant on welfare and subsidies. All hail the brilliance of progressive thought!

    Until we, as Americans, are willing to declare the role of government is to foster conditions that allow the people to create greater wealth, we will have a government that destroys wealth by promoting social objectives to advance political agendas. The rise of the Tea Party has been the most substantive step since the Reagan era to open a discussion of the proper role and scope of government. Clearly, a government that runs an annual deficit over 10% of GDP is acting outside the scope granted by the electorate. If the people want a government with the broad reaching role and scope as our government has today, the people should pay out of pocket to support such a government.

    The reason the United States government is running a $1.5T annual deficit is that the politicians want to reach past what the people will support. By gaining control of corporate resources by fiat and not through the tax code, the government seeks to force corporations to become proxies for social engineering schemes the people aren’t willing to finance through higher taxes. Corporations should actively resist government attempts to interfere with the compact corporations have with society.

    If Obama wishes to force corporations to become mechanisms of his social engineering schemes, let him do it through legislative means. If he is unable to force corporations to promote his social engineering schemes by legislative means, Obama needs to force such schemes upon the people by legislative means. By allowing the people to have a direct voice on such matters, the people can send a clear message regarding the correct role and scope of government. Placing corporate shareholders in the position of sending a message on the role and scope of government is clearly a political device intended to separate the voters from directly speaking on such matters. Americans deserve better from our President.

    Comment by Charles — February 9, 2011 @ 7:29 am

  2. Charles–spot on. I don’t think that people have put this in context with Obama’s “community organizer” background. The standard MO of a community organizer is to exert pressure on the targets (often, but not always, corporations) outside of legal, legislative, or administrative channels and procedures in order to generate a wealth transfer. The organizer relies heavily on rhetoric about the corporation’s “responsibility” in order to put it on the defensive and to justify the transfer.

    I saw this happen over and over again in Chicago. It results in alliances between corporate managements and the organizers and their groups. It is quite effective as an extortion technique, and as you note, it is particularly dangerous because it is not subject to the normal constraints of political, legal, or administrative processes.

    The ProfessorComment by The Professor — February 9, 2011 @ 12:56 pm

  3. Everybody thought building something like the Bridgewater Canal was “economic insanity”.

    Then a visionary built it and canals became an essential part of the landscape of industrial-age Britain.

    Same story for the Erie Canal which opened up the Great Lakes region.

    Ignore the small men of economics, I say. Forge ahead and fulfill the dreams of futurist visionaries.

    Comment by Sublime Oblivion — February 10, 2011 @ 12:30 am

  4. The recent financial recession in the United States gave policymakers an opportunity to pick which companies would be granted taxpayer assistance and be allowed to survive. Politicians, by their very nature, make political decisions. When politicians are allowed to pick which companies will be economic winners and which will be economic losers, they all too often do so based on political considerations. How the Obama administration influenced the treatment of bondholders in the Chrysler bankruptcy is but one example of how politicians sought to grant economic favors to one favored class if individuals, ignoring the lawful rights of others. There are many, many, many other examples where allowing politicians to pick economic winners and losers based on political considerations is harmful to society at large.

    Obama’s crusade for “corporate responsibility” provides a perfect backdrop to offer political favors to corporations that are willing to advance his political schemes and to “punish his enemies” who choose not to involve themselves in various social engineering schemes. We have seen how Jeffrey Immelt of GE and GE itself have both benefited directly by jumping on the global warming bandwagon, even as revelations of fraud continue to cloud the science behind the matter. Some 700 organizations who have signed on to help advance Obama’s political agenda have been granted waivers to Obama’s health care scheme. By circumventing the free market’s function of picking economic winners and losers and substituting the selection of economic winners (by using subsidies, waivers to onerous regulations and by other means) based on political factors is a huge danger to our society and our economy. How people cannot realize this is beyond me.

    Comment by Charles — February 10, 2011 @ 2:27 am

  5. @LL –

    To my knowledge, commercial/ commuter railroads in the U.S. are already mostly run on electric power (some tourist railroads are still steam powered). In the heavily traveled Boston to Washington, D.C. corridor, commuter trains and Amtrack trains are run on catenary wire or diesel/third rail electric designs. The remainder of the trains in the country are almost exclusively run by diesel electric locomotives (diesel generators provide power to electric motors. The electric motors provide locomotion). High speed trains worldwide are almost exclusively based on electric motor propulsion. Off the top of my head, I can’t think of a 125mph+ rail system in the world that isn’t based on a catenary wire/ third rail design.

    Comment by Charles — February 10, 2011 @ 3:08 am

  6. Ah SOB wants to fulfill the dreams of futurist visionaries, mainly ones like Hitler, Lenin, or Stalin of course.

    Comment by Andrew — February 10, 2011 @ 3:11 am

  7. I am wondering if anyone ever looked at feasability of switching the Ameriacn railways to electric power. Not with govermnebtal subsidies but rather with tax benefits, legislative benefits and so on.

    Unlike electric cars, the technology here is well known, nothing to invent (although a few things could possibly be improved). Does not look as sexy as high-speed trains but potentially way more benefitial from any point of vew: from energy independence to environmental considerations (yes,yes, this would most likely involve building a dozen of nuclear power plants in sparsely populated areas and linking them into a single electric grid).

    Comment by LL — February 10, 2011 @ 5:32 am

  8. S/O: Fine. Let visionaries risk their own capital on their visions. If it pays–bully for them. If it doesn’t–so it goes. The government compelling people to pay for crackbrained “visions” is, like I said, insane. Especially when the math is pretty compelling. You can BS about “visions” all you want. Put your money where your mouth is. What I object to is the government putting my money (and yours, someday maybe) where its big mouth is.

    The economics here are not that complicated. Cost: big. Benefit: not nearly so big. You just want to ignore that. Easy to do when somebody else pays the freight.

    As for canals, etc. Do some research. Many states in the US supported canal building in the antebellum period. Most of these went bust. Many states were forced into default on their bonds that they had issued to fund these efforts.

    In other words: don’t cherry pick your historical examples.

    The ProfessorComment by The Professor — February 10, 2011 @ 12:38 pm

  9. > Put your money where your mouth is.

    That would clearly be out of line with S.O.’s usual behavior of preaching insanity (a.k.a. Putinism) while keeping sanely far away from it.

    Comment by Ivan — February 11, 2011 @ 12:36 am

  10. Um guys, S/O is a college student. When he graduates in a few semesters he may decide when faced with the ludicrous U.S. job market to take his Russian language skills and Western passport to Moscow. Will ya’ll call him a hypocrite then?

    Or will it simply be too painful for Washington’s freedom-defining mandarins to observe tens of thousands of educated young people migrate from the ‘mostly free’ Spain, Greece and Irelands of this world to Freedom House’s Mordor of ‘mostly unfree’ Russia and China for work?

    Anyway, they made the decision for these young people by printing so much money that flowed away from the West and into the ‘hot markets’, including oil.

    Comment by The Other Ivan — February 11, 2011 @ 2:51 pm

  11. Moscow is one of the few places in the world where cutting the salaries for the middle aged to make room for young people is actually thinkable without age discrimination lawsuits. In the U.S. the younger Boomers and Gen Xers have kicked everyone else over 55 and under 30 out. If they were out at the end of 2008, then they’re still out, period. The Professor should worry less about corporatist Russia and more about corporatist America.

    I don’t resent globalization so much as I do for thee but not for me. How many CEOs and hedge fund managers fear being replaced by a Chinese or Indian H-1B who will gladly do their job for 10% of their salaries? And when will we finally see Cuba opened up to compete with Big Health Care and Pharma in the U.S.? Oh wait, that’s right, the Embargo is still in place b/c Raul Castro hates our freedom. At least some folks got their heads out at CPAC and booed Dick Cheney.

    Comment by The Other Ivan — February 11, 2011 @ 2:54 pm

  12. @Other-

    What are you smoking? Seriously, I think I want to try some of the amazing stuff.

    “How many CEOs and hedge fund managers fear being replaced by a Chinese or Indian H-1B who will gladly do their job for 10% of their salaries?”

    Do you seriously believe the average Chinese or Indian immigrant is so highly qualified that any of them can walk into any American company or hedge fund and run the show better than the individual currently holding the position? I doubt the the average Chinese or Indian comes from some super race of intellects. I have dealt with Indian software programmers and have found they have technical skills but poor business acumen. As for the Chinese, there is a reason the average American worker is literally 20x as productive as the average Chinese worker. When Chinese eligible for H-1B visas manage to reform their own country, I will believe they can compete in America. So far, I’m not impressed with these people you look up to as having business superpowers.

    As far as the 10% of the salary part of your comment, I agree that there will always be someone willing to take any job at a lesser salary. What you seem not to understand is that the compensation one earns is immaterial. What matters is the productivity of the individual. Personally, I don’t want the lowest priced heart surgeon operating on me when my life is on the line. In America there used to be a company by the name of Earl Scheib. Their claim was that they would paint any car for $29.95. No way in hell would I allow Earl Scheib paint my car. At $29.95 there was no way they could pay for materials and pay anyone who had the ability to do the job properly. Just the same, there is no way in Hell any American shareholder is going to be comfortable allowing Ling-Chi Scheib or Chakrapani Scheib run their company simply becuase they have an H-1B visa and are willing to do the job for $29.95.

    As for your rant about the vaunted Cuban health care system, help youself. I will remain one of the stalwarts working to keep Obama from turning the U.S. health care system into one being run like the Cuban system or being run by a Chinese immigrant on an H-1B visa willing to do the job for $29.95.

    Comment by Charles — February 12, 2011 @ 7:42 am

  13. Charles,

    Please don’t compare heart surgeons and securities traders. It takes a lot of intelligence, attention to detail, and dozens and dozens of years of education and 90 hour-per-week training to become a heart surgeon. It requires no brains and little education to be, say, an AIG trader who buys defaulting sub-prime mortgages and sells $tens of billions of default swaps on them to Goldman Sachs. These morons kept on selling what amounts to call options on these defaults while these defaults were already happening! My dog would have lost less money than the AIG traders.

    Yes, there were/are some smart and educated people at AIG, but most of them were quants, and most of those were Indians. I once knew their head of risk management in Connecticut. He was an Indian. He quit AIG because it paid no attention to proper risk management and moved to Singapore, and invited me to head his quant department there.

    Ditto for most other “Wall Street” players.

    Comment by Ostap Bender — February 14, 2011 @ 1:28 am

  14. Hey Sublime, the Erie Canal was built by an odd mix of state and private investers, not the federal government. And the need for better transportation methods through upstate New York was demonstrated during the War of 1812, there being no railroads and not much of a road system serving the region at the time. The situation with high speed rail is quite different, given the Interstate and highly developed state highway systems , established air travel, and low speed rail. Your analogy reeks.

    The rationale behind Democrat “edifices” is simple. It is payback to unions, who will featherbed the construction process and escalate the true costs. An old-fashioned but tried and true method to transfer tax dollars to political supporters.

    Comment by ruralcounsel — February 14, 2011 @ 9:09 am

  15. Ostap –

    You refer to certain traders as “morons” yet they hardly be considered as intellectually deficient. Even assuming your simplistic analysis of every trader in the securities/ commodities as being identical to those in charge of risk management at AIG, the individuals you look down on sure figured a way to get paid for what they delivered. If a trader is going to get paid to execute a certain trade, how can you sneer at them for making the given trade? It would be the risk managers and corporate management that installed perverse compensation schemes that incentivized the traders to act as they did.

    You seem to be very high on quants (seemingly, under the theory that you are quant and intellectually superior to all other human beings, therefore anyone similar to you must also have intellectual superpowers). A securities traders may not be a human superbeing/ quant, but traders are paid to respond to incentives. As The Professor has stated MANY times, the regulatory schemes in place in the past, in place currently and being contemplated under the banner os Frank-n-Dodd are just as likely to incentivize traders to undertake risk that is inconsistent with shareholder (and taxpayer) interests. The traders are seeking to maximize their personal incomes and will continue to do so. That is what securities traders do.

    I won’t even get into your claim that primarily only Indian quants at AIG were smart and/ or educated. However educated these intellectual superbeings may or may not have been, none of them were capable of forming an argument sufficient to convince management the business model they were executing was fundamentally flawed, so they couldn’t have been all that smart. Additionally, last time I noticed, neither John Paulson nor Greg Lippman was neither Indian nor a quant. Think about that for a while.

    By the way, how many quant heavy hedge funds run by Indians (or non-Indians, for that matter) cleaned up on the subprime debacle? I can’t think of any.

    The traders at AIG reacted to management created incentives and executed trades upon which they were paid, but which were bad risks. These traders weren’t being paid to calculate the risk of the portfolio. There were mostly human potted plants being paid to execute Cassano’s business model. They followed the incentives as they should have been expected to. AIG shareholders lost not because management failed to hire your dog as a trader, but because management has the wrong incentives in place for their traders.

    I am sure your friend who was at AIG and who moved to Singapore is today one of, if not the, world’s wealthiest men. After all, he is Indian and a quant. Don’t such people know more than any trader and therefore can’t ever do anything in the markets but make unlimited amounts of money? Isn’t that essentially your argument?

    Comment by Charles — February 14, 2011 @ 10:47 am

  16. Charles, it is very hard for me to respond to your points. You see, you have no sense of humour whatsoever and you take my sarcastic remarks at face value and then demonise them. What is worse, you also manage to exaggerate my already exaggerated sarcastic remarks. Take for example your remark:

    I won’t even get into your claim that primarily only Indian quants at AIG were smart and/ or educated

    I was being sarcastic, Charles. Get it? And my “friend” at AIG was not a close friend. Just a guy who liked what I did for him and who wanted to hire me.

    But of course you are right that as in all business, the blame lies with the management, not with the average workers.

    And no, my argument is NOT that Indians know more. It really isn’t. Get a life and a sense of humour. I hear you can buy some nice used sense of humour at many Jewish sites for less than $100.

    Comment by Ostap Bender — February 16, 2011 @ 6:45 am

  17. Everybody thought building something like the Bridgewater Canal was “economic insanity”.

    The principal difference being that the Bridgewater Canal was financed voluntarily by a private individual.

    Comment by Tim Newman — February 16, 2011 @ 6:51 am

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