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Public animosity against Wall Street is high. Notably free market economists are taking the position that recent profits in finance are just about playing “heads I win, tails you lose.”
I am skeptical.
I am skeptical because this presumes that the financial industry is amassing profits simply by transferring money from some group of losers to itself. The immediate question is, why would the losers agree to this?
A possible retort is that the losers haven’t agreed to it. The losers may be the taxpayer who is by law forced to pay taxes. This is the bailout explanation.
However, as I have pointed out before, if this were true it would be really nice to see evidence of the taxpayer losing through bailouts. Right now the most direct evidence seems to be that the taxpayer has gained through bailouts.
Another retort might be that the loser is being consistently tricked. This is possible but we have to ask a few questions. One, why doesn’t the loser wake up to the fact that he or she is being tricked? Two, why doesn’t this pool of unrelenting suckers attract so many sharks that they drive each other’s profits down?
This is part of why I was skeptical about the notion of Consumer Financial Protection as doing anything major. Maybe consumers have no idea what they are doing and are constantly getting tricked. Yet, then why isn’t there a market for trust. Indeed, we have financial institutions like Credit Unions which would seem to offer more of the simple trustworthy products consumers advocates would like to see. However, people aren’t choosing them. Why?
Somehow people not only have to be fooled once, but they have to be willing to keep going back to the place that burned them. This implies some sort of fundamental decision making problem with the loser.
A potential answer to all of this is that there are deep biases shared by lots and lots of people. Overcoming that bias is a lot of work for some, but really easy for others. Thus those who easily overcome their biases reap are able to consistently get the better of those who can’t.
This post from Jeff Sommer seems to support that view. Sommer says
With bond yields rising and plenty of headlines about the fiscal pressures on embattled state and local governments, mom-and-pop investors have been selling tax-exempt mutual bond funds in droves lately. In the meantime, professionals have been making rich profits on bonds that have been swept up in the turmoil, including some from deep-pocketed institutions like Cornell and Harvard. There have been some good deals recently on California state bonds as well.
Though University Endowments usually don’t draw the same ire as private hedge funds they have been routinely successful in beating out the average investor. The news stories were about the big losses in the Great Recession, but the real story was the enormous returns made in the years leading up.
More importantly here is a potential source for the bias. Mom and pop investors have a hard time not responding to news stories. This need not be naiveté.
There could be a simple structural explanation. News stories about strained state budgets make it hard for Mom and Pop sleep at night with their retirement in munis. Not being able to sleep at night is a real cost. Mom and Pop sell their assets at a loss to improve their quality of life.
On the other hand, the Money Manager at Cornell is unaffected by news stories. He or she suffers no pain or discomfort from holding munis and so buys them at a gain.
The structural nature of this explanation explains why the market forces can’t make this problem go away. Mom and Pop aren’t consistent suckers. They are people responding to the real costs they face. This discomfort associated with fear of loosing your retirement is a real thing, it can’t simply be waived away.
Moreover, the number of people immune to this fear may also be limited, implying that the number of sharks is fundamentally limited.
In this case there is no natural mechanism that will stop Mom and Pop’s returns from going down and the professional managers returns from going up.
However, to the extent this is true the amassing of wealth in the hands of professional managers increases efficiency in the economy. It turns investment decisions over to people who can produce them at lower cost.
That is to say in this model of the world choosing investments is not simply a matter of information, it is a matter of being able to bear the emotional costs of making certain types of decisions. Sourcing those decisions to people with lower emotional costs really does increase efficiency.
Now to be clear I am not pushing this model as the truth. I am just kicking around ways to reconcile the fact that Wall Street is making outsized returns with what we know about markets and human behavior.
One of the things I have noticed on the blogosphere, Facebook and other outlets where I have access to popular opinion is that skepticism goes out the window when it collides with cynicism.
In an only mild exaggeration, if I were to propose that the moon were made out of cheese, I would be met with a deep skepticism by almost everyone. However, if I were to propose to a unified subgroup, that their sociopolitical adversaries had conspired to make them believe the moon was not made out of cheese the skepticism level would drop dramatically.
Still most people would combat it, but far less forcefully and more on the grounds that “every knows that the moon is not made of cheese” rather than on genuine skepticism.
However, no matter how likely you think it is that some one is tricking you into believe the moon is not made cheese, that must be less likely than moon being actually made out of cheese. For someone to hide the truth from you, it must first be the truth.
Let me give a more concrete but unfortunately more charged example. There is a debate over whether or not the Obama Stimulus worked. As I have said before, I favored a different type of stimulus, both at the time and now. This gives me enough cachet to enter into non-heated conversations with strong Obama detractors.
They ask me frequently whether or not I “really believe” the stimulus worked. I say, “I presume so.” Then they counter with a line of reasoning more or less like the following:
The economy was bad even with the stimulus. It was worse in fact than the Obama administration said it would be without the stimulus. The Obama administration would like us to believe that it would have been even worse without their stimulus. However, this is just a convenient ruse. One cannot prove a counter-factual. Thus we cannot know whether the economy would have been worse without the stimulus. Thus we should not believe the Obama’s administration’s claim that stimulus worked.
This is all well and good except that its an argument that the Obama administration has no credibility on stimulus. That fact alone can’t lower your estimate of stimulus’s effectiveness from what it was before the crisis.
Why?
Well presumably the Obama administration, at absolute worst, will say whatever it needs to say to put the stimulus in the best light. If the stimulus worked, they will say it worked. If it did not work then they will still say it worked.
This implies that statements from the Obama administration are orthogonal to the truth. That is, utterly uninfluenced by it.
However, if a statement is orthogonal to the truth then it cannot rationally affect your estimate of the truth. That is, it simply doesn’t matter what the Obama administration says. Your best guess at the truth is whatever you thought the truth was before. You might as well simply ignore everything the Obama administration says.
Yet, this is not what the argument above is asking. It is asking that I lower my estimate that stimulus is effective based on the Obama administration’s lack of credibility. This is only rational if I think the Obama administration is anti-truth. That is, that they seek to lie even when it is not in their best interest to do so.
Or, said another way I have to believe if the stimulus had worked the Administration would lie to me and tell me that it didn’t. I have to believe they would do this because they enjoy lying or are otherwise motivated to spread disinformation for its own sake.
Said, in additional way, I have to believe not that the Obama administration has no credibility, but that they have negative credibility. If I take what they say and simply assume the opposite, I will be right more than not.
Its an easy proof but beyond this post that negative credibility is credibility. And, that someone who always lied no matter what, is just as trustworthy as someone who always tells the truth. You simply have to logically invert the questions.
So, back to the point, this implies that, at worst, the Obama administration has zero credibility. Negative credibility would be better than zero credibility.
However, zero credibility by definition means that you should believe whatever you believed before. It also by the way, means that the fact that the economy was worse than the Obama administration predicted means nothing. After all, they have zero credibility. Under that assumption, everything they say is meaningless.
The moral of that example is that there is no consistent amount of cynicism about the Obama Administration that should lead you to downgrade your estimate that stimulus worked.
Now, if you independent of the Administration, thought that unemployment would top out at 9% in the absence of stimulus, and you independently hold to that prediction then the fact that with stimulus unemployment rose above 9% is evidence that the stimulus failed. However, it’s a rare person that I meet, who is making this claim.
The moral of the whole post is that assuming your adversaries have low fidelity to the truth is not the same as assuming that they have high fidelity to lies. Generally speaking the worst I should think of someone is that, something is no more or less likely because they told me it was so. I should not lower my skepticism of their proposition being false, simply because they told me it was true.
Will make our lives less worth living until our eventual death anyway.
Paul Krugman complains that its not only the Austerity crowd but the Tight Money crowd that’s switching its tune on the bond markets
So will the OECD call for a drastic shift toward expansionary [monetary] policies, since the clear and present danger, at least according to the bond market, is disinflation (and possibly deflation)?
No, it won’t. The bond market only rules if it tells people what they want to hear.
The odd thing isn’t that people only hear what they want. Confirmation bias is ubiquitous. The odd thing is that so many in positions of authority only want to hear that which justifies greater indifference to human suffering.
Others will see more cynical causes but, my current explanation is that this is a transfer of logic from the way certain body tissues operate. Its clearly the case that skin, muscle and connective tissue respond to stress by growing: a process known as hypertrophy. This might also be the case with nervous tissue and some other, though importantly not all, tissues. This is an interesting and important phenomenon that details the power of highly complex evolutionary systems. Yet, it is a fool’s errand to apply this to the world writ large.
When you stress most things they don’t grow back stronger, they break. When you apply job losses to an economy people don’t become hardier, they become poorer. The idea that tough love will lead to a better economy in the long run is just wrong. Not mean. Not heartless. Not insensitive. Wrong.
Monetary policy doesn’t work that way. Fiscal stimulus doesn’t work that way.
More importantly, I want people to question whether or not you believe in economic toughness primarily because you are extrapolating from your experience with muscle fatigue. Human bias is elusive and works in mysterious ways. You may have learned from an early age that “no pain means no gain” and at a minimum that’s a good rule of thumb when dealing with sarcoplasm. However, this phenomenon is deeply dependent on the nature of sarcoplasm and the metabolic process generally. It does not carry over to the world or equilibrium systems on the whole. You will make deep logical errors if you believe that it does.
And getting the right answer matters. What’s important is not whether what you are saying “feels” true. Unlike Paul, I don’t doubt your sincerity. What matters is whether it is true. The world operates on objective facts and their relationships. The world does not operate on whether you subjectively feel like you did the right or responsible thing. We can talk more later about how responsibility – or compassion for that matter – are mental interpretations. Real world events are the result of the interaction of subatomic particles. Responsibility or irresponsibility can’t cause anything to happen they can only provide an interpretation of events that have actual physical causes. But, like I said more on that later.
The issue today is: what series of logical steps is telling you that we should listen to bond markets when they suggest tighter polices but not when they suggest loose ones?
Is it surprising that conservatives don’t complain more about occupational licensing? On the one hand it’s not, because economists themselves don’t seem to think it’s much of a big deal. In their 2009 paper, Morris Kleiner and Alan Kreuger point out that since 2000 no articles on the issue had been written in what are considered some of the top economic journals: AER, JPE, QJE, Econometrica. In the leading labor economics journals, Industrial and Labor Relations Review and the Journal of Labor Economics, only one article on had appeared. In contrast, there were 16 articles on labor unions in just those labor journals. In a survey of five labor economics textbooks Stephenson and Wendt found that occupational licensing took up a combined total of 10 pages, whereas there were 7 chapters on unions. Clearly the profession is neglecting the issue, so why shouldn’t conservatives?
On the other hand, we have the following graph which shows unionization versus occupational licensing using data from Morris Kleiner*:
Over the last 70 years, occupational licensing come to dominate unionization as a labor market restriction, with growth in the former accelerating in recent years. The most recent estimates are that 30% of the labor force is required to have occupational licensing by a government agency, compare to around 13% that are unionized. Estimates of the impact of licensing on wages are about 10% to 15%, which is comparable to the typical estimates of the union wage premium.
So occupational licensing has the same affect on wages and is more pervasive than unionization; this tells me that conservatives should care a lot about. So why don’t they? One reason may be that they believe licensing increases quality. As I wrote yesterday, in my post on why liberals should care about occupational licensing, the evidence suggests this is not the case. But I don’t think this fact is generally appreciated.
One explanation is that, in contrast to unionism, licensing typically requires workers to jump through some impressive, expensive, and time consuming hoops, which certainly makes it seem like it should increase service quality. Also, one can certainly imagine that for many occupations there is some theoretically optimal non-zero level of licensing, but that public choice problems –highlighted here by Matt Yglesias– make that impossible.
Many conservatives may not grasp the public choice problem, and instead have too much trust in the institutions that set licensing standards. But these are mandatory government institutions, which conservatives should be skeptical of and instead favor free market, optional ones. At the very least they should favor mandatory testing, registration, and certification which allows people to work in an occupation even if they fail, but without the “Government Certified” stamp of approval.
Dean Baker’s hypothesis is that conservatives, journalists, and other professionals not complaining about occupational licensing is about class; specifically, the professional class. He argues that “free traders” only want free trade in low-skilled labor, and not high-skilled labor like doctors and other professionals. This is why they don’t complain when trade agreements come with restrictions on professional labor markets, like those on foreign doctors, but they do complain when they come with restrictions on low-skilled labor.
Even more puzzling, he argues, is that people are more concerned about restrictions on low-skilled trade between countries than on high-skilled trade between states:
The “free-trade” crew want to have a single set of standards for all forms of merchandise traded all over the world, but it has apparently escaped their attention that a lawyer from New York can’t practice across the river in New Jersey.
I don’t necessarily believe Dean’s diagnosis that free-traders really want is “cheap nannies”, and that their motivations are selfish. For one thing he frequently charges journalists with this, but are governmental barriers even among the top 10 things stopping a significant number of immigrants from putting journalists out of jobs? I do think that there is some sort of professionalism bias occurring, but it’s a bias towards believing that high-skilled labor market restrictions are for everyone’s benefit, not just their own.
In any case, whatever their motivations I think conservatives should care more about occupational licensing because it prevents free trade between the states, increases protectionism in professional services, and is a labor market restriction that is as expensive as and more pervasive than unions.
My final comment in this two-part post on occupational licensing is that I would like to see the ideologically diverse individuals and institutions who oppose occupational licensing to work together on this issue. This could be co-sponsoring papers, panels, or entire research programs. Dean Baker at the liberal CEPR, many at the libertarian Reason Foundation, and Matt Yglesias at the liberal Center for American Progress are on the same side and have written passionately about this issue. So why not a CEPR, CAP, Reason joint research program on occupational licensing? Just give me a call when you start handing out research grants.
It is a common and poor framing of the question to ask whether uncertainty is causing our current economic woes. Just as the path of GDP is more volatile and difficult to forecast than in stable growth years, the path of individual firm sales is similarly more volatile and uncertain. More uncertainty will make households and businesses save more and invest and spend less. There is nothing controversial here. The debate is about the cause of uncertainty, and here I see a troubling correlation between what people think the current villain is and what their non-recession bugaboos are. The narratives struggling to tie the current economic woes to long-run stagnating wages, an undereducated workforce, and anything Democrats do strike me as a tenuous stretch and reflect our tendency to need a compelling narrative when easy explanations do not present themselves.
I think a good test for yourself is to ask “what problems do you think are important today that you didn’t think were important in 2004, and what policies would you favor now that you would have opposed then?”. My answer is that low house prices are a problem today where I would previously said low prices are just transfers from sellers to buyers, and I would favor policies that prop them up when I would previously have opposed them. What are yours?
Modeled Behavior 