Heads I Win, Tails You Lose

I live in a very conservative state. Most of the people I meet resent the Federal Government and strongly opposed the Troubled Asset Relief Program that they see as a bailout of overpaid Wall Street bankers who made bad bets on the housing market. The problem is they want to do the same thing themselves and hope that the Supreme Court will let them.

To illustrate, I’ll use a fictional person: Beauregard. Beau works for $13 an hour fixing tractors and other farm machinery in a small garage in a rural township. He’s 32 years old with a long-time girlfriend who has a small child. He drives a battered Ford pickup and lives in a rented house at the edge of town. Until a couple of years ago he never voted. But he was so incensed by the bailout of the Wall Street banks, insurance companies, and then the car companies that he began to help canvass his neighbors for an insurgent candidate for the House of Representatives. The people working on the campaign were “his kind a folk.” Just like him they resented paying taxes to a federal government that then handed the money to fat cat bankers because they had been stupid or greedy, or both. The banks and insurance companies had made bad investments in the housing market but instead of bearing responsibility for their errors and bearing the financial loss or losing their jobs (or both) they were made whole by the largesse of the federal government. Their exorbitant pay has continued and their bonuses increased. The same Wall Street types then fought hard and paid well to stop the government from increasing regulation designed to prevent them from bringing down the economy in the future through their stupidity and greed.

The financial meltdown in 2008 was not just the result of Wall Street gluttony and stupidity. Many players contributed from naïve home buyers, to greedy mortgage brokers, Fannie Mae executives, an ideologically tainted Chairman of the Federal Reserve, and a President and Congress that pushed for wider home ownership. This was a complex financial system that almost imploded because too few people took the trouble to think through the consequences of a rapid rise in the price of houses and household debt. In some measure this is to be expected. As the diversity of desires and interests among the agents increases, the system becomes ever more complex and less comprehensible to its participants even as they make it, and less manageable by governments.

Beau doesn’t understand the details of what caused the financial problems but he instinctively understands that it is wrong to get someone else to pay for your errors. When he screws up a repair job, he accepts his boss’s cuss words and fixes the problem. He wants to do good work and (usually) admits his mistakes. So he cannot understand how a CEO of an investment bank who was paid more than $300 million (numbers Beau can barely comprehend) over a decade can tell Congress that he does not understand why his bank failed and still not get jail time or even something worse. The pain and suffering throughout the economy that they have caused seems like a hanging offense to him. His two brothers lost their jobs in the recession caused by the Wall Street mess and old Mrs. Hubbard down the road lost her house. “That just ain’t right.” People should be responsible for themselves and should not need a government to tell them how to live their lives or fix the problems that they cause for themselves. The government should help people who are harmed by others but not if they screw themselves through their own faults.

But it was not just fat cat bankers that got Beau all riled up. He also hates what he calls “Obamacare” because it will force him to buy health insurance. His boss says he can’t afford to pay Beau’s health insurance and Beau can’t afford it himself. But he doesn’t really need insurance: he hasn’t missed a day’s work in years. And nobody should be telling him to buy something he doesn’t want.

There is a disconnect here. The individual mandate in the Affordable Care Act is designed to prevent the same “free-rider” problem of “too-big-to-fail. If people accept the risk of living without health insurance, they should bear the full, actual cost of health care when they get sick or injured. The individual mandate is designed to make sure that people take responsibility for the risk that they will need health care in the future.

To reject the individual mandate is to demand that we have the freedom to take essentially the same type of risk as the leaders of too-big-to-fail banks: I have more money if I stay healthy but I don’t have to pay for getting sick because someone else will pick up the tab. When an uninsured person (often one of the working poor like Beau) arrives sick or injured at the emergency room, the law requires that they have to be treated. The emergency room is Cadillac care intended for critically ill but everyone else pays when it treats the uninsured. A free-rider problem.

The only solution is to either require that everyone has insurance or deny the uninsured health care when they need it. That is the personal responsibility that Beau and others are demanding bankers should have. It is, therefore, strange that many of the same people who rant about government bailouts of banks and corporations oppose the individual mandate. Perhaps, they feel that if the big guys can live off others, they should be allowed to as well. If enough people think that way and behave accordingly, the system will change and the United States will become something it has not been before. Heads I win, tails you lose . . . and we all lose.

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Sustainable Capitalism is Not That Simple

Gore and Blood (what a pair of names for a polite discussion of sustainability!) have written “A Manifesto for Sustainable Capitalism.” In it they define sustainable capitalism as “a framework that seeks to maximize long-term economic value by reforming markets to address real needs while integrating environmental, social and governance (ESG) metrics throughout the decision-making process.” This definition seems to presume governmental guidance to the market. Who else would produce a “framework”? Perhaps they are hoping that a framework will ‘emerge’ from the complexity of personal choices and corporate interests. If one does, it is unlikely to look like what they wish for. Indeed, it already has in the version of capitalism that we already have.

Governmentality (a faith in the authority of elected officials and their civil service) also shows through in “Mandate integrated reporting”, “End the default practice of issuing quarterly earnings guidance”, Align compensation structures with long-term sustainable performance, and “Incentivize long-term investing with loyalty-driven securities.” These have not yet emerged – indeed what has emerged is current business practice – and likely will not without a push from government to “mandate” what the market cannot provide by iteself. Unsustainability is a market failure that government can correct. Even if we accept the former statement – which is not self-evident – it is doubtful that government can fix it appropriately. Philosopher kings might but Gore and Blood are not of that ilk.

This very conventional approach to sustainability is a reflection of simplistic, reductionist thinking. Do we really know what sustainability is? In my view it is a pathway not a goal, it is a tendency or direction not a specified outcome. As humans change their behaviors, their environment will change both from its own internal processes and our interaction with it. If this is so, humans will have to continually change their behaviors: no silver bullets exist – and likely never will.

What does it mean for humans to change their behaviors? This is about more than corporate governance or profit horizons. It is about how interactions between economy and society change who we are, what we want, and how we behave. Capitalism, as Marx knew, is not only about firms and markets. It is in the end about society and the people within it that society constructs.

Capitalism may become sustainable but in the end it is down to the mass of individuals (some of whom control the decisions of firms) to choose what is both good for them and for the planet. We are a long way from that.

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Leading in Complexity

We constantly hear that there is a dearth of leadership in this country, that David Cameron needs to lead in the UK, that we need leaders to save us from ourselves. What is leadership in a complex society? Is it good or useful?

Leadership is variously defined but essentially amounts to influencing a group of people, or everyone in the nation, to change their behavior so that they act collectively toward some goal that the observer wants. Coaches want captains to enthuse the team to win, Tea Partiers want leadership to shrink government, and business people want economic leadership so they can figure out how to increase profits. Leadership is getting everyone to do something that they would not otherwise do to produce some outcome.

Leadership is benign authority. Instead of forcing us to change how we behave and change the choices we make, leaders persuade is. We follow them and do as they suggest because we choose to. Authority forces us to change our behaviors; leadership makes us voluntarily change.

Leadership and authority often are conflated. The coach and the captain can lead the team because they have the authority. In political circles, the U.S. President can fix the economy because he has the authority to lead if only he would choose to. David Cameron, the British Prime Minister, can lead in stopping the recent riots, because he can force the police to change tactics.

Authority simplifies systems. By forcing specific behaviors it reduces the diversity of responses to changing conditions. Leadership does the same. If leadership unifies behaviors among diverse agents, it has the same effect through a different channel. Authority changes behaviors but leadership changes the mental model of agents. While the effect may be comparable the mechanism is not. Ethically, leadership may be more generally acceptable but the effect is the same: the system is simplified. Whether all agents choose to act the same way because they have adopted the same mental model or whether they are required by authority to act the same way, the observed effect is the same. Complexity is wrung out of the system.

Is simplification of the system good? In part that is a matter of judgment. If the simplification unifies the behavior of disparate agents toward a preferred goal, presumably it is. But if complexity benefits the system, increases it resilience and adaptability, any simplification is negative.

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A Constitutional Problem

Many Tea Party supporters carry a miniature copy of the U.S. Constitution in their pocket as they complain about how Washington does business. They want spending reigned in—except for the programs that they like or depend on—and the deficit reduced. Little do they know that the problems they decry are caused by their little book.

Although in which dimensions it may be isolated from the rest of human society is not clear, for our present purposes it reasonable to treat it as a system and to accept that it is complex. A system can be defined in terms of the rules that govern the connections and relationships among its elements, and its purpose. The rules that govern the United States are clear, it purpose is contended.

What is the purpose of the United States? It is to provide for the security and welfare of its citizens. Exactly how to translate that into government structures and policies is debated, in this election quite angrily. Similarly, there is no consensus on the degree to which the nation differs from the fifty states.

One thing, however, is clear: what the United States is and how it operates politically is governed by the rules that established it. If you are really angry about how politics is done or how ‘Washington operates’, you do not have to look far: it is in your pocket. The US Constitution determines the structure of politics and how values such as the purpose of the system are debated.

The Constitution is a creation primarily of the eighteenth century experiences of wealthy colonial landowners. As such it requires that the executive branch is weak and subordinate to the Congress. It is curious, therefore, that so many American voters expect the President to fix the economic ills created by the economic decision of 300 million consumers. How can a President who is dependent upon Congress for policy rules create or prevent economic booms or busts, especially in a globalized economy?

Why does Congress behave as it does? In large part because of the rules set by the Constitution. If 535 Representatives and Senators are venal and spend citizens’ money irresponsibly, it is because of the rules governing their election from the 50 states. If Senators are responsible to whole states and Representative to districts, they will seek the greatest benefit for the people who elect them. If everyone wants something from the Federal government, the easiest way for the 535 to get re-elected is to give them something by spending someone else’s money. That is natural not malicious. Sending new faces to Washington will have little effect.

Finally, it is appropriate for Americans to look in the mirror. To what extent has more than two centuries of living within the rules of the Constitution defined what it means to be an American? How has that history created a culture and education system that has molded the expectations and purposes of the citizens of the United States? Surely, it means something to live in America under the rules of the US Constitution. It molds our lives and beliefs in myriad ways even if we cannot define exactly how it makes Americans.

Good or bad, America is the way it is because of the rules established at its foundation. The Constitution is a beautifully worded, politically debated document that encapsulates a negotiated philosophy that is firmly grounded in the 18th Century. And it has made American what it is. To make it something different we would need to change its purpose or the mind-set that underlies this system. Because the Constitution determines both how the purpose of the US system is decided and the mind-set that underlies the system, we would need to change the Constitution. And the Constitution has rules for that, too.

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Irrational Irritation

According to at least one commentator “everybody, everywhere” is “upset over the economy.” It may be true, although the article actually shows that only Republicans and older people are actually angry. But no sane person should be angry at the economy. It’s like being angry at the weather.

The US economy is the sum of the actions of 300 million Americans, thousands of firms, and even the choices of people, governments, and firms beyond our shores. If this not producing what we want, perhaps we want the wrong things. Our expectations, shaped by decades as the world’s leading economic power, are too high.

Americans should be angry at themselves. If they have lost their job, or their house is ‘underwater’, or can’t afford a new car, they are directly or indirectly the cause of their own suffering. Assuming that ‘the economy’— that they think of as something separate from the people who constitute it—will always grow and give them more, Americans have spent too much, borrowed too much, and saved too little for the rainy day that has now arrived. Their anger is like King Lear on the heath raging at the storm. Except that this storm is one we have created for ourselves.

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Disaster Afoot?

Flooding in Pakistan, smoldering peat fires in Russia shrouding Moscow in thick smoke, and drought in Europe. Is this what climate change looks like? US income inequality growing, profits rising as a share of national income, unemployment staying high, the stock market up 70 per cent from last year’s lows. Is this the face of a Marxian collapse of capitalism? The answer to both questions is: it’s too early to tell until it’s too late. That’s the nature of complex systems.

The climate is a complex natural system which is why scientists have not been able to come up with precise forecasts of the effects of increased human emissions of greenhouse gases. Skeptics who claim that the inability of climate models to forecast next year’s weather do not understand this. Because the atmospheric system interacts with complex terrestrial and oceanic systems and the effects of those interactions are then visited upon a complex human system, it is not possible to predict what ills society will suffer. And because this is a singular event without precedent, probabilities are guesswork. It would seem to be prudent to avoid the worst predictions of the effects of climate change but governments are unable to act and individuals are ineffective. The system is too complex to be pushed around by bickering politicians; possible policy changes are meaningless. Only a change in the underlying ethic of the system or the ideas and beliefs in the heads of the mass of individuals can have any useful effect.

The underlying ethic of the system is capitalism and something similar is happening in the wholly human world of money. In the US (and many other rich countries) income inequality is growing and wealth is increasingly concentrated in the hands of the few. The great mass of the population have less to spend so they in the last two decades they have borrowed more and remain tapped out. Poorer people have a higher marginal propensity to consume than rich people who save more of their income which is why extending unemployment payments has a greater effect on consumption and incomes than reducing taxes for the rich. Therefore, if the rich increase their share of national income, consumption should decline. Consumers only were able to increase consumption from 63% of GDP to 70% by borrowing heavily and that cannot last forever as we have seen in the last two years. Meanwhile, corporate profits continue to grow their share of national income. Just between Q1 2008 and Q1 2009 profits grew from 23.55% of national income to 25%. If corporate profits continue to grow and the rich continue to get rich, who will be buying? Marx warned that an excessive accumulation income and wealth by the capitalist class must inevitably lead to insufficient consumption to support production, leading to a collapse of production and profits. The rich who are powerful in a capitalist society cannot help themselves. Only a few got hurt in the economic collapse of 2008-2009 while millions living payday to payday lost their jobs. But will they suffer when consumption, the engine that drives the US economy, fails to continuously increase and production and profits fall? Will the economy collapse from insufficient demand or will it just limp along for years?

Neither climate not capitalism is susceptible to the sort of easy fix that politicians can sell and voters can understand. If not doomed to massive changes in climate or economic collapse, we are doomed to more of the same including fiercer storms, more drought and floods, and greater economic volatility.

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Reduce the Cost of Banking

In a column in the Financial Times, John Kay comments that the financial innovations that were much lauded in the 1990s and that contributed to the 2008 financial meltdown were designed to manage risks that it caused. They do nothing for the average person. In this he agrees with this blog that innovations in financial markets have benefited Wall Street at a cost to society at large even if Blankfein thinks Goldman Sachs is doing “God’s work.”  

The chairman of Britain’s Financial Services Authority queries the social value of most modern financial innovations and Paul Volcker has commented that the only useful recent financial innovation has been the ATM. There is an increasing recognition (except among free-market idealogues) that deregulation allows markets to run away from their purpose to provide a net benefit to society. However, regulations rarely succeed in reigning in an industry as rich and powerful as banking and finance.

It is not possible to force markets to provide specific benefits to society. But it should be possible to reduce wayward behavior that serves only to reward the players and do nothing for most of the rest of us. Societies survive and thrive by inhibiting practices that are bad for the society and encouraging practices that are good.

Complexity suggests – and most people except bankers, their lobbyists and politial shills, and free-market idealogues – would agreethat we must cut the banking industry’s political power by reducing the biggest firms down to a more reasonable size so that their market power is less intrusive. Increase competition and diversity (much the same thing as diversity breeds competition and competition encourages innovation and diversity) among market players so that the market (and the industry) is less able to suck rent from the economy and harm society.

Now, where to start if Wall Street owns Washington . . . .?

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