December 15, 2009
How not to create a better society
The insufferable New Economics Foundation yesterday issued some idiocy of the highest order, declaring that bankers are economically “worth less” to society than cleaners. The appalling NEF methodological fallacies have already been enumerated by Giles Wilkes here.
Indeed, Giles reckons that the NEF “sets back the task of finding a truly just way out of this fiscal mess”. He’s right.
Sensible economic bloggers like Chris Dillow, Duncan, and Giles have been pointing out for months that a big part of the “banker problem” is to do with incentives. In the boom years banks and financial actors were incentivised to buy and re-sell debt whose true risks they didn’t know, or to issue NINJA loans, because during the bubble this worked. Profit was made, big time. Reform that will prevent future disaster, and foster a productive banking sector that doesn’t fuel social inequality, requires a careful restructuring of incentives.
Bankers and their bonuses fall into this wider picture. Investment banks pay their staff bonuses because so far this has worked for banks. A culture of high-risk, high-remuneration saw staggering profits up until 2007-8, with a return to the good times in 2009. Bankers themselves demand high bonuses because not only do they know they can get them, but in a banking environment where firms compete for staff by offering huge remuneration packets it makes sense for individual bankers to be greedy.
So part of the story for dealing with financial reform is incentive restructuring, which must be undertaken in a dispassionate, objective, level-headed manner. The NEF “report”, by contrast, amounts to little more than adolescent screeching and petulant antagonism. It adds nothing constructive.
But incentives alone musn’t be the whole story for the left. Before he passed away last summer, the brilliant political theorist Jerry Cohen explored the importance of collective social ethos in any society which aims to be just. Cohen believed there would be severe problems for any society in which individual agents lacked an “ethos of justice”, who simply bargained for what they could get given their market position, irrespective of any negative socio-economic impacts. Crucially, institutional arrangements alone would not suffice to secure justice. What efficacy a windfall tax on bonuses, if the bankers lack a social ethos that it is wrong to avoid the tax, and hence do so? How can a society be just if bankers take themselves to be masters of the universe, and employ their lobbying power to secure lower taxes and less regulation to the detriment of others?
Cohen was a Marxist, but non-Marxists on the left can form common cause here. In recent years there have been moves towards left “republicanism”, which calls (to caricature horribly) for an emphasis on social solidarity through collective civic action, to empower citizens by rediscovering the ties that bind. This is opposed to the hegemony of “liberalism”, which has grown to prominence since the 19th Century, and treats individuals as self-sufficient agents for whom the state must simply provide a “sphere of non-interference”. For although liberalism has brought much good – unrivalled liberty and tolerance for individuals, the growth of democratic society, and the (decidedly mixed) blessings of capitalism – it has also fostered a social “atomism”.
Y’know, the sort of society in which bankers view themselves as sufficiently isolated that they fully believe they are entitled to obscene bonuses, having just crashed the global system, plunged millions of people into dire straights, and following a year when thick chimps could have made money.*
The left would do well to concentrate on building a collective ethos of justice, fostering a society in which the social stigma against heinously selfish actions are internalised by economic agents, and thereby cut-off at root. No doubt a project of restructuring institutional incentives will help promote this end. Institutions, after all, profoundly influence all our lives and world-views.
But one thing that is certainly not going to help is bad economics, dishonest methodolgy and a response to profound crisis which is the equivalent of screaming “We don’t care what you think, because you’re rubbish anyway!”
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* Because with interest levels so low and the global system underwritten by taxpayers, banks could hardly have failed to do well this year.
Grace said,
December 15, 2009 at 9:42 pm
“In the boom years banks and financial actors were incentivised to buy and re-sell debt whose true risks they didn’t know…Reform that will prevent future disaster… careful restructuring of incentives.”
The passive verb – “were incentivised” – masks the key issue here – why were incentives so skewed? there’s a good case to be made which says that the skewed incentives were a product of regulation and not a natural tendency of the banking sector. just one example, the Recourse Rule, a 2001 amendment to the Basel 1 accord, gave a 20% risk weight to asset-backed securities but only a 50% weight to an unsecuritised mortgage. other causes of skewed incentives are (effective) implicit govt guarantee of fannie and freddie etc.
if the cause of skewed incentives is the failure of bureaucrats to judge market conditions/risk effectively (unsurprising!) this suggests that the best way of stopping this happening again isn’t for a central planner to “carefully restructure” incentives or anything of the sort. what if they get it wrong again?
“In a complex world where nobody really knows what will work until it is tried, competition is the only way that people’s endless capacity for error can be checked, and loss is the regrettable but inescapable result….If we seek the sources of a systemic failure, a logical place to look is among the legal rules that govern the system as a whole. Unfortunately, being legal mandates, these rules–unlike the different strategies pursued by competing capitalists–aren’t subjected to a competitive process. So if they are based on mistaken ideas, we all suffer the consequences. That turned out to be the case with the Recourse Rule.” http://causesofthecrisis.blogspot.com/2009/09/three-myths-about-crisis-bonuses.html
“productive banking sector that doesn’t fuel social inequality” – what if this isn’t possible? if efficiency requires inequality, incentives/capital accumulation etc? (i think my pessimism regarding a drastic improvement in the “social ethos” is justified)
“social stigma against heinously selfish actions” – what exactly do you mean by this? i don’t think profit-maximising on its own (eg bankers) is “heinously selfish”, even if people are seeking unequalising incentives… wanting money isn’t evil, i may just have expensive tastes or want to give a lot to my preferred charities. if you’re thinking of evil bankers taking excessive risks and bringing down the system, surely this is a sign that the economic externalities of their actions have not been internalised – for example the banks gained hugely from implicit govt guarantees, yet didn’t pay for them (deal: bankers make money, they keep gains; bankers lose money, taxpayer absorbs losses). surely this economic issue can be taken care of by economic measures – like removing implicit/explicit guarantee of banks (splitting up the ones that are too big to fail)… then the costs of risk would fall squarely on those responsible, eg bankers would lose their jobs if they lost money? no need to attempt the mammoth/impossible task (esp. through the state!) of remaking humanity
side point: i dislike the sweeping labelling of “bankers”. not everyone who works in a bank and trades stuff is responsible, even a little bit, for the crisis. eg my father, he trades currencies and stuff, *never* bought any dodgy securities. sentences like this “bankers view themselves as sufficiently isolated that they fully believe they are entitled to obscene bonuses, having just crashed the global system, plunged millions of people into dire straights” may be rhetorically effective but perhaps a little simplistic? bankers aren’t a unit
(by the end was cohen really a marxist? i might just be betraying my ignorance but he didn’t seem very marxist in i’m an egalitarian/rescuing justice and equality, eg no materialist conception of history/normative political philosophy instead of “science” etc)
Paul Sagar said,
December 15, 2009 at 9:54 pm
1. Bizarre that you think the crisis was caused by a failure of incentives set by the government/scary-sounding central state planner. Most people tend to think the bad incentives were a product of deregulation – i.e. less involvement from government.
2. “i don’t think profit-maximising on its own (eg bankers) is “heinously selfish”,” Great. I don’t either. I’m thinking more of the attitude of bankers re their obscene pay-packets and their belief that this is something they are unconditionally entitled to irrespective of wider social ramifications, or the conditions that make their obscene pay-packets possible. And rhetoric about being “wealth creators”, and attitudes that everyone else still owes them a favour, so should get back in the boxes. Etc. You’re kind of missing the point with your text book economics extrapolations, IMO.
3. Of course bankers are not a unit. But generalisations are required in a piece of 700 words. One rather loses one’s point if every time a distinction and qualification could be made, one makes it. I suppose it would make you happier if I wrote “bankers, except the good guys like Grace’s dad”, but it would clutter the piece somewhat and rather detract from the substance without adding anything that anybody with half a brain can infer for themselves. But out of interest, does your Dad think he deserves a bonus, and that it shouldn’t be (windfall) taxed? If so, remind him that he wouldn’t have a job (or an economy in which to find one) without the little people.
4. Arguably Cohen wasn’t a “Marxist” when he died. But again, he’s generally thought of as one and it hardly matters for this short piece if I leave out the fact when he died maybe he didn’t self-identify as such. Then again, his last book was called “Why not socialism?”.
Paul Sagar said,
December 15, 2009 at 10:29 pm
Interesting reading for you from a man much cleverer than me:
http://www.nextleft.org/2009/05/if-youre-egalitarian-how-come-you.html
freethinkingeconomist said,
December 16, 2009 at 10:15 am
Just to focus on the bit I know about (I defer to all you experts on Jerry and the Marxists):
Why do bankers get paid so much?
1. because banks make so much money
2. and bankers are powerful visavis the banks themselves, so shareholders do not get it all. Compare CitiGroup to Microsoft
Why 1.? Because it must be uncompetitive. Monopolies of scale, in retail banking undiscriminating customers, some hidden subsidies. More ‘entry’ into banking would be nice. Insofar as hedge funds eat the banks’ cake, they are good . . . . but .. . .
Why 2? Because bankers are mobile, can take customers, expertise and in some ways brand with them. Slavery abolished circa 1806. And the calculus when a financial employee threatens to leave is not only his value-add but his value-take-away. Which customers will follow him? Which lower level staff? How much hassle am I saving myself by promising an extra £XX of (someone else’s-the shareholder’s) money?
So I think it is about power, mobility, industrial structure. Almost anything BUT how nef explained it.
freethinkingeconomist said,
December 16, 2009 at 10:16 am
I would point out on the “incentives side” that:
Cayne, Fuld, and the rest were perfectly aligned with shareholders. Though maybe they should have been paid in subordinated debt?
Some people with no incentives at all can screw up organisations. Google “Orange County” and “derivatives”.
The incentives went beyond banking. Think of the regulatory tradeoffs to intervening to stop Northern Rock in 2006.
Grace said,
December 16, 2009 at 3:24 pm
1. “most people”, the majority opinion on the crisis is untrustworthy given the public’s appalling lack of economic knowledge (see the survey of americans and economists on the economy for massive lay-expert belief gaps across the whole of economics, eg public think immigrants destroy jobs). i don’t think it’s a “bizarre” view, there are quite a few economists who believe it, eg people at adam smith institute (though i can imagine how you think of them!), steven horowitz (department of economics at st lawrence univeristy). see his “open letter to my friends on the left”, http://myslu.stlawu.edu/~shorwitz/open_letter.htm
3. yes he thinks he does deserve a bonus because he works very hard making lots of money for the bank, and gets a minuscule proportion for himself (his bank are stingy with bonuses) – and that the size of his bonus is more to do with petty office politics than his performance. his ideas of desert might not stand up to philosophical attack (eg he’s convinced he deserves his natural talent, as arbitrary and lucky as things get!) but that wouldn’t bother him, he doesn’t think much of philosophy. and i very much doubt he’d ever get a bonus large enough to be windfall taxed (i wish lol).
talking about “greedy bankers who wrecked the economy” just obscures so many issues. eg all the other agents responsible for the crisis – regulators (my father doesn’t have a very high opinion of the fsa, to say the least), central bankers setting easy monetary policy, etc. also we don’t know (at least i don’t) what exactly has happened to the bankers directly responsible for dodgy loans etc. for all you’ve told us, they could have lost their jobs (as many have) – the group of bankers now demanding bonuses aren’t necessarily the same as those involved in trading sub-prime.
4. sorry how does entitling a book “why not socialism” imply he was a marxist? (you can be a socialist and not a marxist, he keeps on referring to socialist principles of justice in rescuing justice and equality, all the camping trip stuff hardly seems marxist).
one other point. we both agree that incentives during the crisis were skewed, i think we disagree in what way. in “In the boom years banks and financial actors were incentivised to buy and re-sell debt… because during the bubble this worked. Profit was made” etc suggests that you have a problem with the high returns, bonuses etc encouraging bankers to take on lots of risk, getting rich quickly and not thinking about wider consequences. however i’m not sure this is right, banks who gave shares to their traders instead of cash bonuses suffered no smaller losses (eg dick fuld lost $1bn). this suggests to me that the problem wasn’t that bankers were incentivised to try to make lots of money quickly, since those holding shares should have wanted the company to do well in the long term, but that they were pushed into (what turned out to be) bad areas eg subprime by regulation, eg recourse rule.
Dan said,
December 16, 2009 at 6:19 pm
I would point out on the “incentives side” that:
Cayne, Fuld, and the rest were perfectly aligned with shareholders. Though maybe they should have been paid in subordinated debt?
Right – how much did Fuld lose personally? Something like a billion dollars? That suggests to me that the problem is not really huge bonuses leading to principal-agent problems, even if a lot of folks on the left would really like this to be the case.
Paul,
Bizarre that you think the crisis was caused by a failure of incentives set by the government/scary-sounding central state planner. Most people tend to think the bad incentives were a product of deregulation – i.e. less involvement from government.
This seems to me to be a pretty lame response to the fairly detailed points Grace was making. I mean, I could be biased since I find her points independently plausible, but don’t you yourself often talk about how economically illiterate “most people” are? And didn’t you yourself link approvingly to Jeffrey Friedman (the source of her points) not that long ago?
Incidentally, is Grace the same Grace who used to post a while ago? I could have sworn she used to be fairly egalitarian, or at least that way inclined.
Grace said,
December 16, 2009 at 6:56 pm
“The financial crisis and ensuing economic mess was ….due to a crisis of regulation, as this excellent article by Jeffrey Friedman makes clear.”
paul, you said this in october! and link to the very same article (sorry for linking it again). why do you now not take his argument seriously? what’s made you change your mind?
yes it is the same person, i’ve changed my mind on some issues but what have i said that would indicate i am no longer an egalitarian (it’s perfectly consistent to hold “right wing” views on economics, eg crisis of regulation not capitalism, and “left wing” views on justice, eg morally arbitrary inequality is unjust)
Paul Sagar said,
December 16, 2009 at 9:26 pm
Dan,
Yes, maybe abrupt. But I see most of Grace’s points as being fairly repetetive and misguided. And I’m very busy, so I reserve the right to be short…
Grace,
Yes, I did. But what I meant was that the crisis stemmed from the regulation being set up the wrong way (read: it was a) insufficient and b) poorly structured such that the incentives pointed towards a system culminating in disaster). although I appreciate that the source I quoted thinks that the answer is less regulation, I disagree on the prescriptive point. But I can agree with him that a crisis of regulation was the cause.
I don’t see anything inconsistent in my positions.
By contrast, you will observer with me, Dan, that Grace has some dilemmas coming up if she thinks her distributive egalitarianism and sense of “leftie” justice is going to continue to sit well with your-style libertarianism. (I mean that without passing any judgements on your political philosophy, and simply a prescriptive-descriptive claim about the (in)compatability of world views).
Dan said,
December 16, 2009 at 10:11 pm
yes it is the same person, i’ve changed my mind on some issues but what have i said that would indicate i am no longer an egalitarian (it’s perfectly consistent to hold “right wing” views on economics, eg crisis of regulation not capitalism, and “left wing” views on justice, eg morally arbitrary inequality is unjust)
Fair enough, perhaps it was a hasty assumption; of course, it’s an unusual combination of views to hold, and I’d be interested to know how you reconcile them. As for morally arbitrary inequality, I think anyone who uses that phrase should be forced (in a non-coercive way :) ) to read Susan Hurley’s work on luck-egalitarianism – in my view, she leaves it in tatters.
Also, proving that the world is a small place, someone purporting to be you has literally just popped up on my Facebook feed talking about the NEF (I am friends with Ben and James). If you’re at Oxford, you should definitely come along to some Oxlib stuff!
Grace said,
December 16, 2009 at 10:16 pm
It seems to me that the whole point of the “crisis of regulation, not capitalism” quote is to say that the problems we’ve seen aren’t the inevitable or even likely result of a free market in operation (crisis of capitalism thesis – which you seem to be sympathetic towards) but instead have been caused by something external – regulation. at the end of that article he basically says that since regulation artificially alters the structure of incentives – channels investment into the direction the regulators want – it has potential to be extremely dangerous and damaging, since if investment goes in the wrong direction, then losses will be concentrated and massive (as in subprime). there’s no way for a central planner to predict with the great accuracy required which directions of investment are good – so regulation = bad.
so it seems to be twisting the idea behind the quote to say you agree with it, saying that it was a crisis of insufficient regulation is too close to saying it was a crisis of capitalism for the contrast in the quote to make any sense
Grace said,
December 16, 2009 at 10:25 pm
Dan – I wish! (have applied to balliol, don’t expect to get in)
I came along to eric mack… i asked a question at the end about self-defence, were you the one doing the introducing?
ok i haven’t read any of susan hurley’s papers, so i might be jumping the gun, but is she the one who says that there is no non-circular way of specifying a luck egalitarian baseline, so ideas of luck and arbitrariness can’t provide an argument for equality? if she is then i think i agree with her. but this doesn’t leave luck egalitarianism in tatters, perhaps some moral convictions (eg equality) are so basic that we can’t explain/justify them by reference to other principles. yes there’s no non-circular way of arguing for egalitarianism, but maybe there’s no non-circular way of arguing for any principle so basic (how would you argue for the NAP? have asked ben about this with no non-circular response). we just have to accept this, and move on, with worries about using force on others, this is a big reason why i feel all warm and fuzzy inside when thinking of a world with completely open borders, a wide range of societies, people can genuinely choose which values they want to guide their society.
(and yes it is me on the news feed, very small world! :D)
Paul Sagar said,
December 16, 2009 at 10:33 pm
Dan,
You can be concerned about morality arbitrary inequality and not be a luck egalitarian, let’s not forget (Rawls, Jonathon Wolff, etc etc)
Grace,
I know he thinks it’s a crisis of regulation not capitalism. I was originally quoting him – if I remember – to broadly illustrtate that “crisis of regulation” was more accurate than “bankers bonuses caused the crash”.
But:
“but instead have been caused by something external – regulation. at the end of that article he basically says that since regulation artificially alters the structure of incentives – channels investment into the direction the regulators want – it has potential to be extremely dangerous and damaging, since if investment goes in the wrong direction, then losses will be concentrated and massive (as in subprime). there’s no way for a central planner to predict with the great accuracy required which directions of investment are good – so regulation = bad.”
I can just counter-point and say: without regulation you get even worse cases of cumulative-risk disaster, so that would be even worse. Central planners will certainly get things wrong, but hey, the big banking crises (1929, 2008) came in periods of lower regulation, and in the latter case came after periods in which regulation installed after the first crisis as a preventative measure was stripped away. He says: regulative structures pushed incentives towards crash, no regulation would have been better. I say: that’s unlikely, as it was insufficient regulation that resulted in the disastrous incentives, what worked in the past was more regulation.
Fair enough, I’m more inclined to say that capitalism is inherently prone to crisis unless regulated, which obviously he is against. But please, some sensitivity to my original quoting: namely, as a way of moving on from inane chatter about banker’s bonsuses. You can say I’m being dishonest or whatever, but frankly I think that’s unfair. He thinks the solution to a “crisis of regulation” is less regulation. I think the answer is better (read: more) regulation. Again, it’s a difference on prescriptive solutions, not descriptive diagnoses.
Dan said,
December 16, 2009 at 10:34 pm
Yeah, I was the one introducing Eric Mack.
I’ve added you on FB so we don’t have to clutter up poor Paul’s blog with Susan Hurley chat.
Paul Sagar said,
December 16, 2009 at 10:37 pm
S’alright, I like the traffick.
Grace: The libertarians are seductive. Comprehensive world views are. Try and keep an open mind, despite the comfort and security the paradigm will provide…
Dan said,
December 16, 2009 at 11:02 pm
I can just counter-point and say: without regulation you get even worse cases of cumulative-risk disaster, so that would be even worse. Central planners will certainly get things wrong, but hey, the big banking crises (1929, 2008) came in periods of lower regulation, and in the latter case came after periods in which regulation installed after the first crisis as a preventative measure was stripped away. He says: regulative structures pushed incentives towards crash, no regulation would have been better. I say: that’s unlikely, as it was insufficient regulation that resulted in the disastrous incentives, what worked in the past was more regulation.
What Friedman is saying is that too much homogeneity in a financial system leads to bad consequences when the dominant model breaks down. It’s much better to have multiple, vigorously competing models because then at least if there is a problem with one model at least it won’t lead to a systemic meltdown. Fine; this much you should be able to agree with. But Friedman also I think makes the basically Hayekian point that a regulator laying down rules which govern how a financial system deals with risk will, because their job is essentially central planning, not have the requisite knowledge to make the right judgements (see e.g. the Basel Accords and the Recourse Rule). The upshot is that, sure, “better regulation” would be nice. But the regulation that we are ever in a position to get is going to have the slight defect that it lays the entire financial system open to systemic failure. Sure, it would be nice if regulators could successfully come up with general rules that manage to limit risk. But if you think about how much of the information needed to manage risk in each particular is tacit and local, and you think about what kinds of information regulators will have, it’s pretty easy to see that the problem isn’t going to be solved by stamping our feet and demanding better regulation.