Chris Dillow's Blog, page 163

Payday loans: statism vs libertarianism

The proposal to limit payday lending rates raises a nice contrast between the libertarian and statist lefts.

The issue here is not that APRs of 4000% are extortionate. For one thing, it's not clear that it makes sense to annualize the rate on what should be short-term loans, any more than it's sensible to say the FTSE 100 rose at an annualized rate of almost 10,000% this morning.And for another thing, such rates reflect high default risk; there might be good reasons why "legitimate" lenders don't undercut the likes of Wonga.

Instead, there are three issues here that have general applicability to the distinction between the statist and libertarian left.

1. The yuk factor. Those who want payday lending curbed think it repulsive that some should profit from the desperation of the poor. To them, the argument against payday loans is similar to that against markets in human organs; markets are unlikely to have acceptable outcomes if one party is desperate.

To libertarians, the yuk factor is less important than the fact that even apparently unequal transactions can be mutually beneficial; paying 4000% APR is unpleasant, but it's less unpleasant than having your electricity cut off or having to borrow from folk like Rick Neelan.

2. Should we protect people from themselves? The danger with payday lending is that the availability of credit will tempt people to spend more than they can afford and so such loans - rather than being a rare last resort in an emergency - will become regular, and thus onerous.

Libertarians don't respond that people are fully rational; few of us are wholly immune from akrasia or projection bias (pdf). Instead, they don't believe the state should protect people from themselves - especially when doing so comes at the cost of depriving some people of (occasionally?) beneficial loans.

3.Should political change be piecemeal or radical? Left libertarians say the best way to help the worst off is not to restrict payday lending, but rather to raise their incomes, for example through a high citizens' income.The statist left replies that this option is not available.Practical politics thus requires more modest but attainable policies, such as curbing payday loans. The same reasoning leads to other anti-libertarian policies such as the minimum wage.It's no accident that gradualists tend to be statists.

Which brings me to my worry. There's a danger that good practical politicians such as Stella Creasy, concerned to advance the interests of the poor one law at a time, get distracted from the need for more radical reform. And this can - entirely inadvertently - help encourage the closing of the Overton window against such policies.

* Ms Creasy is sound on one of the great scourges of our age.

On social change

Norm expresses an old fogey's scepticism about whippersnapper Owen Jones' claim that "with a bit of a shove - the whole edifice [of wealth and power] could shatter." As one of middling years, I'm in two minds about this.

I side with Norm because history suggests that social systems rarely change solely because of conscious collective action. Feudalism didn't disappear because of a peasants' revolution, and dissidents weren't the prime cause of the collapse of communism. "Whole edifices" tend to shatter not (just) when they are shoved, but when their material economic foundations weaken.

Which brings me to two reasons to side with Owen.

1. Perhaps the foundations of hierarchical capitalism are weakening. The longstanding investment dearth is a sign that capitalism can no longer see the monetizable projects it once did, and so - as Marx predicted - is now a fetter on growth rather than an engine of it. And large parts of hierarchical capitalism are faltering: retailers and the media are in decline; banks would have disappeared but for state support; and mass production has long since left the west.

2.Organizations are brittle; quite small changes can cause them to suddenly and unexpectedly collapse. This is not just true of companies but of social systems; think of the demise of communism. One reason for this is what Timur Kuran calls preference falsification. People support a system because they believe that others do so, and sometimes they wake up and realize this is not true. Thanks to this, says (pdf) Kuran, "revolutionary surprises will occur repeatedly."  

Now, you might think here that, despite this, a socialist revolution is improbable.

It is, if you think a revolution is a Battleship Potemkin-type uprising of starvelings from their slumbers. But this is not the only type of revolution. The industrial revolution was perhaps the greatest transformation in human history. But it took decades, and few of those who lived through it - Marx being an exception - thought they were part of a revolution.

And perhaps we are seeing a slow-motion revolution. Credit unions and peer-to-peer lenders, owners of coffee shops competing against Starbucks, the steady rise in the numbers becoming self-employed, the growth of bloggers, tweeters and file-sharers are all taking small - not necessarily deliberate - steps away from hierarchical capitalism, just as early factory owners made small contributions to the industrial revolution.

What Erik Olin Wright calls (pdf) interstitial transformations can ultimately add up to more radical economic change than windbags on marches.

What can Governors do?

How much influence can individuals have over the economy? This is one question raised by the appointment of Mark Carney as the Bank of England's new "quality guv'nor".

The media-political class think the answer is "a lot" - hence the Times' headline "Chancellor banks on top outsider to save economy."

Sadly, we'll never get a clean answer to this question because we'll never see two economic histories side by side, one with Carney as Governor and one with Tucker. But I suspect there are limits to what Mr Carney can achieve:

1. He cannot set monetary policy targets. That's the job of the Chancellor. Granted, a Governor could, in principle, stimulate the economy by forecasting low inflation and thus setting a loose policy. But his ability to do this is constrained, in part by the fact that low inflation forecasts might not be believed by outside economists or financial markets.

2. Ability might be irrelevant for monetary policy. One way in which this might the so is simply that even amateurs can quite quickly learn how to set reasonably effective monetary policy. Alternatively, it could be that inflation is so unpredictable that no amount of ability will be much help. Paul Ormerod has written (pdf): 

Given that the change in inflation is indistinguishable from a random series, [MPC members] not know what the rate of inflation is going to be in, say, one year’s time. Specifically, they do not know whether it will be higher or lower than it is at present. So their ability to control the rate of inflation, to meet the target, is very seriously constrained.

3.New research warns us that large parts of policy-makers' CVs might be irrelevant. Marc-Daniel Moessinger has found that although finance minsters' age and political experience are associated with lower public borrowing, their "educational background or ideology have no significant impact on public debt changes." Why should the backgrounds of Governors matter more?

4. The fact that Canada weathered the global crisis well might have little to do with Carney. Here's Andrew Coyne:

That our banking system was not so badly mauled by the crisis as others had, of course, less to do with Carney or any current officeholder than with the historical and policy inheritance they came into: if any single person deserves credit it’s probably Mike Wilson, author of the sweeping financial regulatory reforms carried out under the Mulroney government in the 1980s.

We might add that Canada's position as a net commodity exporter and the fact that its domestic savings exceeded domestic investment in the 00s (thus reducing the chances of high bank leverage) also helped.

I'll concede that Mr Carney might be better able than King was to deal with any future financial crisis. But this might owe less to personal dispositions than to the facts that the Bank will have more power to deal with such crises in future, and that we are intellectually less ill-prepared for a crisis now than we were in 2007.

None of this is to say Mr Osborne should have gotten anyone off the street to be Governor. The role of Governor is not so much to shape the economy decisively as to give the impression that he is in control. It is here that Mr Carney's background - at Goldmans as well as at the BoC - helps. It equips him to give outsiders the impression that he knows what he's doing, whatever the reality.

I suspect the best precedent for Mr Osborne's decision is Fabio Capello's appointment as England manager. That experience taught us that when an impressive CV hits a dysfunctional structure, the structure stays in place. It also taught us that, when this happens, people find lots of ways of blaming the individual and thus avoid having to question their ideological faith in the importance of individuals rather than structural forces.

Does background matter?

There's one thing that critics of Cameron agree upon that I want to question. It's the idea that their wealth and background disqualify them from being able to represent "ordinary" people. For example, Nadine Dorries worries that politicians are "distant from the people voting and can never truly represent them". And Tim Roache of Class says (about 18' in) that rich MPs can't make policy about poverty because they've never experienced it.

But if I go to the doctor with an ailment, the doctor doesn't need to have had the same illness if he's to cure me.I don't care what his medical history is, or whether he "feels my pain". What matters is that he has the knowledge to put me right. The same is true for most professions; expertise matters, not background.To paraphrase Arrigo Sacchi, you don't need to have been a horse to be a good jockey.

And history shows that posh MPs can serve working class interests. Leading members of the 1945-51 government such as Attlee, Dalton and Cripps were public schoolboys. But they contributed to the most radical leftist government we've had (a low bar, admittedly).

Why, then, are Dorries and Roache - and countless others - concerned that politicians be more representative or "engaged" with voters? I fear there are two unpleasant things at work here.
One is a conception of politics as a pure marketing exercise. The question of whether MPs are in touch" with voters serves to deflect attention from the tougher question of which actual policies best advance the interest of the worst-off. I suspect Dorries did not go into the jungle out of a desire to promote effective anti-poverty policies.

Secondly, there's a belief that the only knowledge that matters is direct experience; Tim seems to think that only the poor can truly understand poverty.This is doubtful. And what's even more doubtful - in fact plain wrong - is that direct experience of poverty is necessary to know which policies are best to relieve poverty.

It is not the background of Cameron, Freud and Osborne that stops them making effective anti-poverty policy. It is their ignorance and ideology. 

Freud's class bias

Lord Freud says:

People who are poorer should be prepared to take the biggest risks; they’ve got least to lose.

This seems ignorant of basic economics and psychology. Yes, the poor have less to lose. But the little they have is more important to them. A loss which means you don't eat is more painful than one which means you can't replace the Merc this month. That's the diminishing marginal utility of wealth. For this reason, we should expect the poor to be less prepared to take risks than the rich. And the econometric evidence seems (pdf) to roughly support this.

Granted, the poorest 10% spend proportionately more on gambling than the rich - but it accounts for only around 1% of their overall spending compared to less than 0.2% for the better-off (table A6 here). And some of this difference, I suspect, reflects the fact that the rich gamble on better odds (eg spread bets versus the lottery) and so reduce their net spending, and also do some of their gambling by buying shares. The facts that the City is "rife" with gambling addicts, that horse-racing has traditionally been "the sport of kings" and that Monaco is renowned for its casinos tell us that many of the rich have long been tolerant of risk. Which is consistent with diminishing marginal utility of wealth. 

Why, then, is Freud making a claim which has such a suspect empirical basis?

Class, that's why. Take these statements:

The rich should take more risks. They should use their wealth and their so-called skills to set up new businesses and create jobs, rather than stay in cushy rent-seeking jobs in management and finance.

The problem with the rich is their selfish reluctance to pay tax. They should be more responsible citizens with better tax morale.

Such views are not often expressed by the likes of Freud.This is because of a class bias. Rulers often see the attitudes and behaviour of the poor as a problem to be solved by exhortation and policy, whereas the attitudes of the rich are givens, to which governments must adapt. Hence Freud's hectoring of the poor but not the rich.

This asymmetry is an old one; I suspect you could find it in ancient Rome. Here's C.B. Macpherson on the 17th century:

The Puritan doctrine of the poor, treating poverty as a mark of moral shortcoming, added moral obloquy to the political disregard in which the poor had always been held...Objects of solicitude ot pity or scorn and sometimes of fear, the poor were not full members of a moral community...But while the poor were, in this view, less than full members, they were certainly subject to the jurisdictions of the political community. (The Political Theory of Possessive Individualism, p226-27)

There's not been much intellectual progress in these last few centuries.

Economists as dentists

Is the "crisis" in economics one of the content of the discipline, or rather of its social function? I ask because of a point made by Ronald Coase:

The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate (hat tip to Paul).

It's certainly unfortunate, because the economics that can help people with the "ordinary business of life" is actually thriving.As I've said in the IC, there's a tremendous amount economics can offer to investors.We know the distribution of asset returns and therefore their risks. We know the cognitive biases that can lead to widespread poor investment performance, and we can both quantify their effects and identify some of the stock market anomalies they generate. And we know about the maths of how to diversify. All this, and more, allows us to give useful investment advice.

Of course, we can't predict the future. But perhaps we don't need to: those investors who had used the Halloween and May Day indicators in 2008 would have avoided the worst of the 2008 crash.  

In this regard, economists are indeed living up to Keynes' famous ideal:

If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.

Like dentists, we can't greatly enrich people's lives, but we can offer reasonable advice on how they can avoid a few nasty problems.

Why, then, should we think economics is in crisis?

The obvious answer is that we didn't see the crash of 2008 coming.

But is it even logically possible to foresee the future? G.L.S Shackle thought not, because individuals' choices, which are what determine economic outcomes, are not forecastable - and his argument has been ignored rather than rebutted. And Gary Gorton has said that "Financial crises are not predictable", in part because they arise from cascade-type behaviour which cannot be foreseen.

Put this another way. Imagine economists had widely and credibly warned of a financial crisis in the mid-00s. People would have responded to such warnings by lending less and borrowing less (I'm ignoring agency problems here). But this would have resulted in less gearing and so no crisis. There would now be a crisis in economics as everyone wondered why the disaster we predicted never happened. The point is that forecasts can only be right if they are not believed.

Instead, I suspect there's another reason why economics is thought to be in crisis. It's because, as Coase says, (some? many?) economists lost sight of ordinary life and people, preferring to be policy advisors, theorists or - worst of all - forecasters.

In doing this, many stopped even trying to pursue Keynes' goal. What sort of reputation would dentists have if they stopped dealing with people's teeth and preferred to give the government advice on dental policy, tried to forecast the prevalence of tooth decay or called for new ways of conceptualizing mouths?

Perhaps, then, the problem with economists is that they failed to consider what function the profession can reasonably serve.

What's an AAA rating worth?

Paul draws my attention to a daft question from Andrew Selous:

Does the Prime Minister agree that the United Kingdom’s retention of its triple A status, when France lost its triple A rating this week, shows that the UK retains the confidence of international markets because of the difficult but necessary decisions that we are taking?

I say it's a daft question because as Jonathan has repeatedly pointed out, low gilt yields owe more to fears about the weakness of the global economy than they do to "the confidence of international markets".

But let's look at this a different way. What is an AAA rating worth? Perhaps the cleanest simple measure comes from the US municipal bond market. Here, AAA-rated 10 year bonds yield 1.5%, whilst AA-rated ones yield 1.61% and A-raters yield 2.32%. This implies that a one-notch downgrade from AAA status would raise yields by only 0.11 percentage points; small wonder, then, that reaction to France's downgrade was so puny. However, a two-notch downgrade would add around 0.8 percentage points to gilt yields.

How much damage would this do to the economy? If we take the Bank's estimate (pdf) of the impact of QE as a guide, a 0.8 percentage point rise in gilt yields would reduce GDP by 1.6%; I suspect this is a maximum estimate. This is equivalent to 470,000 jobs, which is not much more than the fall in public sector employment since late 2009. 

However, such an impact is easily avoided. The Bank of England estimates that its first £200bn of QE reduced gilt yields by around one percentage point. This implies (with caveats) that the adverse effect on yields of a two-notch downgrade could be offset by another £160bn of QE.

On balance, I suspect that our AAA rating is worth something, but not very much, and it's benefit is probably not as great as the cost of securing it.

Put it this way. By 2014-15 the coalition will have tightened fiscal policy by 2.1% of GDP more than under Labour's plan (table 3.1 of this pdf). There are three conditions which, jointly, would justify this:

1. This is the minimum tightening necessary to prevent a two-notch downgrade, or worse.

2. The fiscal multiplier is low. If we assume a 0.8 per cent rise in yields would take 1.6% off GDP, then a multiplier of less than 0.76 (1.6 divided by 2.1) would mean that the tightening does less harm than the downgrade.

3. QE is for some reason infeasible or less effective in reducing yields than the Bank's estimate.

Personally, I suspect these conditions don't hold.Instead, there's a danger that our AAA rating today serves the same function as sterling did in the 50s, 60s, and 70s - as a national virility symbol, to which the economy is sacrificed.

Marx vs Coase: experimental evidence

Are firms efficient institutions for responding to uncertainty, as Coase thought? Or are they, as Marxists believe, means whereby capitalists exploit workers? A new paper by Ernst Fehr and colleagues provides experimental evidence.

They split subjects into principals and agents, and asked them to try to form either employment contracts or sales contracts. Under sales contracts, the agent performed a set task. Under employment contracts, the principal could assign the agent to one of three possible tasks; one of which paid well in one state of the work, one of which paid well in another, and a third which was inefficient in aggregate but very profitable for the principal.

This set-up highlights the difference between Marxian and Coasian theories of the firm. For Coasians, employment contracts are better because they allow the principal to respond to uncertainty by assigning workers to the more efficient task when that task cannot be identified in advance: as Coase said (pdf), "it seems improbable that a firm would emerge without rthe existence of uncertainty." But for Marxists, the danger is that they allow workers to be exploited - to be assigned to the third task.

Fehr and colleagues found that, in one-shot encounters where employment contracts were struck, 51% of principals exploited agents. "The Marxian idea that power can be used for exploitation is real" they conclude.

Why only 51%? It's because there's a norm of fairness which stops some principals exploiting workers. This norm is a two-edged sword. On the one hand, it promotes efficiency, as it encourages agents to enter into the more flexible employment contract rather than sales contracts in the belief they'll be treated fairly. On the other hand, though, this belief might prove mistaken - and so the fairness norm actually facilitates exploitation.

However, in repeated encounters, the prevalence of exploitation dropped to 21%. This is because employers wanted to build a reputation for fairness which they could use to encourage workers to stick to employment contracts.

Simple as it is, this gives us a framework to pose the question: under what conditions are we likely to have Coasian rather than Marxian firms?

One is where there's a strong norm of fairness. You can read the campaign for a living wage as an effort to build such a norm.

Another is where firms have a desire for a reputation as a "good" employer. This is more likely to be the case under conditions of near-full employment, where they have to compete for for workers.

A third is the existence of strong unions. Fehr and colleagues say:

To the extent to which reputational forces alone are insufficient for solving the employers’ moral hazard problem, labor unions and labor legislation can play an efficiency enhancing role by constraining the employers’ ability to assign the workers inefficient tasks.

This corroborates my suspicion that strong unions can be good for an economy.

There is, however, a fourth possibility - for workers to have an outside option such as welfare benefits that allow them to reject exploitative contracts.

The fact that many of capitalism's supporters reject this fourth course makes me suspect that what they are interested in is not so much efficient Coasian firms as the power of capital to exploit workers.

Victoria Coren: the cause of the crisis

There is a gap in the many analyses of the financial crisis: none of them, as far as I know, have blamed it on Victoria Coren. Let me remedy this omission.

Start with the premise that the crisis was due in part to a decline in trust and trustworthiness. The spread of self-certification mortgages - "liars' loans" - allowed mortgage borrowers to overstate their income. And mortgage originators were content to lend to bad risks in the belief that they could sell on bad loans. Untrustworthy behaviour thus contributed to high leverage. And then the collapse in interbank lending and freeze in the mortgage derivatives markets reflected a decline in trust; banks just didn't trust other banks or the assets they had created.

But what caused this decline in trust and trustworthiness? In Animal Spirits, George Akerlof and Robert Shiller point to a curious coincidence - that in the 00s more people played poker and fewer played bridge.This, they say, is culturally significant. Whereas bridge requires cooperation between partners, poker is a more individualistic game, in which bluffing is important.

It could be, then, that the rise of poker and decline of bridge is a sign of the growth of distrust and individualism that contributed to the crisis.

A new paper corroborates this. Italian researchers got bridge and poker players to play trust games, in which one player decides how much to send to a partner and the experimenter then triples the sum sent, and the trustee then decides how much to return. They found that bridge players were significantly more likely to trust their partner in the trust game than poker players. On average, they sent 17% more than poker players, and 31% of bridge players sent everything whereas only 20% of poker players did.

This difference was not because bridge players are more altruistic or risk-tolerant; in fact, the researchers show, they are less so. Instead, it reflects the fact that bridge players are more like "we-thinkers" than poker players; they are more inclined to trust others in the belief that trust pays.

We know that culture affects economic outcomes. So isn't it plausible that a less trustworthy culture might have contributed to the crisis?

But is the rising popularity of poker merely a symptom of a growing untrusting culture, or is it a cause?

This is where Ms Coren comes in. She is, econometrically speaking, an instrument. Her success and her best-selling book, have helped popularize the game, independently of other cultural developments doing so. And it's plausible that playing poker doesn't just attract untrusting individualistic types but helps to create them. As Screwtape said, "All mortals tend to turn into the thing they are pretending to be."

In this sense, therefore, Ms Coren deserves some blame for the crisis. She is arguably an even greater blight upon the economy than Konnie Huq.

* Cynical readers might think this post is motivated by the jealousy of a spurned admirer. Would I be so desperate? I obeyed the injunctions. What more could I  do?

"Credibility"

Jonathan Portes describes his encounter with the Treasury Select Committee:

None of the questioners on this topic seemed at all interested in why I make the arguments I do, nor were they prepared to put forward any countervailing evidence of their own. They didn't define "credibility"; they didn't specify what the "incredible" counterfactual would look like; they didn't try to explain why "credibility" should matter from a theoretical perspective; they didn't try to present any empirical evidence that "credibility" had in fact resulted in lower gilt yields.

There's a reason for this. When the political class use the word "credibility", they don't intend it to be a testable proposition. It is, instead, a political "X factor" - something ill-defined but nevertheless desirable in leaders. So, for example, when the Telegraph asks "is Labour's EU policy credible?" it could have replaced "credible" with "reasonable" or "correct". But to have done so would have invited rational analysis in a way that "credible" does not.

Used this way, "credibility" serves an ideological function, in three ways:

1.It is used to define which policies are acceptable to the capitalist class, which fall within the Overton window. Austerity and "sound money" are "credible" even if they are not necessarily in the short-term interests of all capitalists. I suspect that this is the sense in which Jesse Norman was using the term. He and Jonathan were divided by a common language.

2. There's a dog whistle element here. Take the question: "is Ed Miliband a credible leader?" Objectively speaking, it's a silly question. His MSc in economics makes him more academically qualified than almost all previous Prime Ministers, and in 2015 he'll be older than Cameron or Blair were when they became PM. But objectivity isn't the point. By "credible" people mean "not too left wing" or geeky or (I fear) Jewish.

3. "Credibility" helps personalize politics and, in doing so, divert attention away from impersonal power structures. What Richard Sennett wrote almost 40 years ago is perhaps as true now as it was then:

A political leader running for office is spoken of as "credible" or "legitimate" in terms of what kind of man he is, rather than in terms of the actions or programmes he espouses. The obsession with persons at the expense of more impersonal social relations is like a filter which discolours our rational understanding of society; it obscures the continuing importance of class in advanced industrial society. (The Fall of Public Man, p4)