Monthly Archives: October 2014

Luigi Zingales on Economists’ Capture

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I passed on listening to this podcast with Russ Roberts last week, but Russ insisted that the paper is important, and I have come around to agree. Zingales concludes,

The purpose of this article is to highlight the parallelism between the forces that we use to explain regulatory capture and the ones that can capture economists. Unless we economists are made of a different fabric of the regulators, I do not see why we should not be subjected to the same kind of pressures.

Based on the analysis of these forces, I discuss several mechanisms to can help prevent (or reduce the effects of) capture: from a reform of the publication process, to an enhanced data disclosure, from a stronger theoretical foundation to a mechanism of peer pressure. Ultimately, the most important remedy, however, is awareness of the problem, an awareness most economists still do not have.

Read the whole paper. I thought that Zingales’ proposed remedies were too much on the clever and cute side. A couple of examples

Social handicaps make a person less suitable to an industry job, reducing the value of what business has to offer down the line and thus reducing a possible channel of capture.

If authors can post rejection letters, they can embarrass the editors when they make mistakes, especially when these mistakes seem to be driven by outside interests.

The conventional wisdom is that issues of professional ethics revolve around who pays you to do research. But money is not necessarily the driving force in economists’ capture. To borrow an expression from Roberts’ new book on Adam Smith, economists will respond to those who make them feel lovely. So if your paper with a statistically significant result gets published and your paper with a statistically ambiguous result does not, you stop submitting papers with ambiguous results. If the one-sided, uncharitable opinion pieces that you write get widely circulated and praised, then you stop writing charitable, balanced pieces. If the unreliable study that gets a result that is so exciting or pleasing that the press picks up on it, then you stop worrying about whether your results are reliable.

Although Zingales is correct to stress that it is vital for economists to be aware of the issue of capture, I would go further in the direction of deep cultural change, as opposed to clever incentives or procedural tweaks. I think that the challenge is to make feeling lovely align with intellectual honesty, as opposed to just getting articles accepted at journals or being a popular opinion-writer. That in turn requires thinking about, agreeing about, and caring about what it means to be intellectually honest.

My thoughts (these ideas may overlap):

1. Fight against confirmation bias. Work very hard to convince yourself that you may be wrong, and work less hard to convince yourself that you are right. When you come across a paper that goes against your views, look for its strong points. When you come across a paper that aligns with your prior views, look for its weak points. (I think that failure to uphold this standard accounts for a lot of the degeneration of academic journals. More generally, it contributes to the tend toward conformity and unreliable research findings rather than open intellectual inquiry and genuine progress.)

2. Resist the temptation to write in ways that work to persuade those with whom you agree to keep their minds closed. Instead, seek to open their minds to possible problems with their ideas.

3. In the political realm, try to pass Bryan Caplan’s ideological Turing Test. State the other side’s case in a way that they would mistake you for being one of them.

4. Be charitable to those with whom you disagree. Try to engage their strongest arguments rather than harping on their weakest arguments.

5. Steer clear of asymmetric insight. That is, do not claim to understand your opponents better than they understand themselves.

6. In particular, steer clear of reductionism. Rather than trying to explain away other’s beliefs, assume that others have arrived at their views on the basis of reason.

People, Countries, and Debt

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James Kynge writes about China,

Total debts owed by the government, companies and households have ballooned to 240 per cent of gross domestic product, virtually double the level at the time of the global financial crisis.

This ratio, it is true, remains modest next to some in the west; US debts stand at 322 per cent of GDP, Ireland’s at more than 400 per cent, while Greece and Spain are at about 300 per cent each.

Pointer from Tyler Cowen.

To me, it seems careless to add up the liabilities of government, companies, and households. I object to taking the sum of these numbers and saying “China owes ___.” The debt is not owed by an entity called the country of China. It is owed by disparate entities within the country of China. And much of it is owed to disparate entities within China.

Speaking of which, it also seems careless to ignore assets. Suppose somebody has a $300,000 mortgage and a $30,000 income. You might say, “wow, their debt is 1000 percent of their income!” But that is not so alarming if they have $1 million in assets (maybe the house itself is worth $1 million).

I’m not trying to dismiss the issue. Just the other night, one of my favorite economists pointed out that if the debt burden on the Chinese government starts to pinch, then it might have to stop buying (or even start selling) American government bonds. That could fuel a rise in interest rates, and then the debt burden of the American government would spike up. If that happens, have a nice day. But a high ratio of total liabilities of all of the entities within in a country to its GDP is at best a very imprecise indicator of financial distress.

Bank Regulation, Left and Right

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One possibility I am considering for this panel discussion is to give a spiel on how free-market economists have been more hawkish than mainstream economists when it comes to bank regulation. I was inspired by listening to Robert Litan recount some of the history at a talk last night on Trillion Dollar Economists. You may recall that may take on that book is that it has great material, but I would have liked to see different organization and emphasis. I was reading it with my high school economics students in mind.

Anyway, here is the spiel.

Long ago, two groups of free-market economists decided to “shadow” the Fed. The Shadow Open Market Committee, which I believe started in the 1970s, issued pronouncements critical of monetary policy. The Shadow Financial Regulatory Committee (SFRC) , issued pronouncements critical of regulatory policy starting in 1986.

The SFRC had both a deregulation agenda and a regulation agenda. Their deregulation agenda was mainstream. Observers of banking regulation across the political spectrum recognized that deposit interest ceilings were no longer workable, that the Glass-Steagall separation of banking and securities was no longer workable, and that prohibitions against interstate banking and branch banking were no longer workable. People had known since the late 1960s that those regulatory boats were sinking, and the laws that Congress passed in the 1980s were just the long-awaited permission to abandon ship.

Take Glass-Steagall, for example. In 1968, the distinction between a loan and a security was obliterated by GNMA. A few years later, the distinction between a deposit and a security was obliterated by money market funds. Even though some people try to blame the financial crisis on the repeal of Glass-Steagall, the fact is that it collapsed 20 years before it was repealed and nobody has said that you could bring it back.

It was the SFRC’s hawkish regulatory agenda that was out of the mainstream. In particular, if you read through its old statements, you will see that the SFRC issued many warnings that bank capital regulations were inadequate. They pleaded for tighter regulation of Freddie Mac and Fannnie Mae, for higher capital requirements for banks, and for regulators to require banks to have a thick layer of subordinated debt which would put the onus for failure on the private sector rather than the taxpayers. These calls went unheeded. The SFRC economists were viewed as cranks, whose judgment on these matters was impaired by an irrational distrust of government agencies.

Principles-Based Regulation for Food and Drugs

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Anahad O’Connor writes,

The Food and Drug Administration frequently recalls dietary supplements that are found to contain banned substances. But a new study suggests that many of these products return to store shelves months later with the same dangerous ingredients.

With principles-based regulation, you look at companies to see if they have processes in place to ensure that they follow the right principles. Do the health-food stores have people in charge of checking the labels of what they put on shelves? Do the companies that manufacture drugs have people in charge of making sure that they do not put known dangerous chemicals into the drugs? Do the companies that import drugs from overseas have processes in place to ensure that they are not tainted? etc.

When you find processes that are flawed, you order fixes. When find an absence of processes, you impose heavy penalties, which might include prison for the executives.

W Bent the Cost Curve

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Loren Adler and Adam Rosenberg write,

Despite constituting barely more than 10 percent of Medicare spending, our analysis shows that Part D has accounted for over 60 percent of the slowdown in Medicare benefits since 2011 (beyond the sequestration contained in the 2011 Budget Control Act).

So, it was not so much Obamacare that slowed the growth in Medicare spending. It was the market-oriented and much-reviled prescription drug plan enacted under President Bush.

Tax-free Savings Accounts

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Chris Edwards says that they are working in Canada.

In just the past year, TFSA account assets increased 34 percent, and the number of accounts increased 16 percent. In June 2014, 13 million Canadians held $132 billion in TFSA assets. Given that the U.S. population is about 10 times that of Canada, it would be like 130 million Americans pouring $1.3 trillion into a new personal savings vehicle.

Edwards also links to a 2002 proposal for Universal Savings Accounts.

Of course, if you believe in secular stagnation or the r-g is a big problem, then the last thing you want to see is more saving.

The Financial Supermarket Bubble and Banking History

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Here is a chart, using the Google ngram tool, showing the frequency of the appearance of the term “financial supermarket” over time.

Note the spike in the mid-1980s. Given that these are books, which appear with a slight lag, I would say that the spike in the media was in the early 1980s.

At this panel, I don’t know whether I will have time to get into the history of bank concentration in the U.S., but here it is.

1. The market share of the largest banks follows a hockey stick pattern since 1950. It stayed very low until the late 1970s, and then around 1980 it started to grow exponentially. Growth of banks had been retarded by ceilings on deposit interest rates, branching restrictions, and Glass-Steagall restrictions. Banks had been trying to find loopholes and ways around these restrictions, and regulators had been trying to close the loopholes. Then, during the period 1979-1994, the regulators stopped trying to maintain the restrictions, and instead cooperated in ending them. That was when the hockey stick took off.

2. The regulators thought that this would bring more competition and consumer benefits. What the banks had in mind was something else. That is where the chart comes in. The bankers all thought that “cross-selling” and “one-stop shopping” would be killer strategies in consumer banking. In 1981, when Sears bought Dean Witter, many pundits thought that putting a brokerage firm inside a department store was going to be a total game-changer.

3. It turned out, though, that consumers did not flock to brokerage firms in department stores, or to any of the other one-stop-shopping experiments in financial services. The economies of scope just weren’t there.

4. Meanwhile, concentration in banking soared thanks to mergers and acquisitions. I’ve read that JP Morgan Chase is the product of 37 mergers and Bank of America is the product of 50. All of these took place within the past 35 years.

5. Just five years into this exponential growth process, Continental Illinois became insolvent, and that was when “too big to fail” began. So out of the 35 years where we were on the exponential part of the hockey stick, 30 of them have taken place under a “too big to fail” regime. In short, the concentration in banking got started during the “financial supermarket” bubble, and from then on was supported, if not propelled, by “too big to fail.” But the market share of the biggest banks is not something that grew naturally and organically out of superior business processes.

6. As another historical point, when the S&L crisis hit, the government set up the Resolution Trust Corporation. Each failing institution was divided into a “good bank” and a “bad bank,” with the good bank merged into another bank and the assets of the bad bank bought by the RTC. While this was a somewhat distasteful bailout, it was conducted under the rule of law. When TARP was enacted in 2008, Congress and the public were led to expect something similar to the RTC, with TARP used to buy “toxic assets” in a blind, neutral way. Instead they ended up calling the biggest banks into a room and “injecting” TARP funds into them. They also spent TARP funds on restructuring General Motors. It was the opposite of government acting in a predicable, law-governed way. It was Henry Paulson and Timothy Geithner making ad hoc, personal decisions. I think that in the U.S., that is what bank concentration leads to–arbitrary use of power. That is why as a libertarian I do not think that allowing banks to become too big to fail is desirable.

Some Uncharitable Thoughts

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Regarding Mark Thoma’s links from the other day.

1. Will Americans ever vote for a far-reaching wealth tax?–Roger Farmer.

No, but we will have one, anyway.

2. Enhance Stability by Improving Culture–William Dudley.

Look who’s talking.

3. Is mortgage credit too tight?–Calculated Risk.

Not by the standards currently set by politicians. If you tell banks you have zero tolerance policy for making type I errors (making loans that eventually default), you have to expect many type II errors (passing up good loans). Of course, 10 years ago, the political pressure was the opposite.

Surveying the War on Poverty

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Michael Tanner looks at a lot of literature. His conclusion:

Looked at objectively, continuing the War on Poverty is unlikely to further reduce poverty, increase self-sufficiency, or expand economic mobility. More anti-poverty programs and more welfare spending are not the answer to continued poverty. Fifty years of failure is enough.

Of the many papers he refers to, I looked at one by Bruce D. Meyer and James X. Sullivan.

We find that consumption poverty, after adjusting for biases in price indexes, declined by 26.4 percentage points between 1960 and 2010

What they argue is that consumer prices rose less rapidly over the past 50 years than the official figures show. That means that real incomes were lower 50 years ago than the data would indicate. That in turn raises their measure of poverty fifty years ago.

I am not sure whether or not I agree. I

In any case, the poverty rate is one of the most messed-up statistics out there. You would think that poverty would be defined in absolute terms, as the ability to afford X amount of food, Y amount of medical services, Z amount of housing, etc. Instead, it is defined in relative terms, so that if you were to double everyone’s income, poverty would remain the same.

Quarantine the FDA

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Robert Goldberg writes,

These companies could start producing Ebola vaccine/treatments tomorrow — except that the Food and Drug Administration’s insistence on randomized studies and endless demands for more data means firms have to spend millions on paperwork instead of producing medicines.

Try to imagine a randomized study for an ebola vaccine conducted on human beings. “We’re going to expose hundreds of people to ebola, half of whom will have been given the vaccine and half of whom will have been given a placebo.”

One idea I have is a separate agency that uses principles-based regulation instead of rules-based regulation. Companies could elect to abide by this alternative regulator and bypass he FDA.

Having said that, I am generally not in favor of taking the latest media-inflated crisis and saying that it confirms one’s political outlook. And I am not suggesting that the ebola story should be used to confirm mine.