A Zizekian look at the GFC

21/01/2014 § 3 Comments

A bit gauche, perhaps, but I’m going to point you to an article I had published at the end of last year. It is my attempt to grapple with economics and the global financial crisis. Because of the nature of the explanation, it appeared in the International Journal of Zizek Studies.

The content will be familiar to regular readers of this blog — Zizekian philosophy and Lacanian psychoanalysis can help explain the economy. Given that it’s an article and not a post, it works through the arguments more fully and with better references.

The work started with two things I couldn’t understand:

  1. why were reputable economists and economics commentators spouting nonsense about the GFC? I don’t mean different interpretations of facts, or bringing different sets of values/preferences to bear on the evidence. I mean relying ‘evidence’ that was not true, developing explanations based on falsehoods
  2. why weren’t more economists concerned about the fraud revealed by investigations into the GFC? It seemed like the central players in the economy were cheating, brought down the economy, and then imposed the costs on other people.

A brief bit from the article:

In the response to the GFC, mainstream economic theory has acted as a prop or a magician’s wand, to be waved around as a distraction. What happened in the actual economy represented a turning away from standard, textbook capitalism, based on the idea of capital as a factor of production. Owners of capital should receive returns – get paid – because they own that capital. In addition, the more they take risks with that capital, the more they should be rewarded when they are successful. First, the fundamental principles of ownership and contract were replaced by a focus on smooth functioning of bureaucratic process. Secondly, the financial sector was able to decouple risk from reward; reward for taking risks no longer describes the origin of returns to capital.

Let me know what you think.

Preferences for avoiding death

30/04/2013 § 7 Comments

Slate blogger Matthew Yglesias has been getting flak for his post that appeared quickly after news of the factory collapse in Bangladesh. In it, he explained that economics was all about diff’rent strokes for diff’rent folks:

Bangladesh may or may not need tougher workplace safety rules, but it’s entirely appropriate for Bangladesh to have different—and, indeed, lower—workplace safety standards than the United States.

Reactions in Western corners of the internet have been fierce and occasionally funny:

Corey Robinson questions whether Yglesias is right about the collective preferences of Bangladeshis:

‘Hundreds of thousands of garment workers walked out of their factories in Bangladesh Thursday, police said, to protest the deaths of 200 people in a building collapse, in the latest tragedy to hit the sector.’

Would it not be easier for Matt Yglesias to dissolve the Bangladeshi people and elect another?

Justin Zachary at Daily Kos points out that the factory was in fact in violation of local safety laws:
What happened in Bangladesh was the result of the safety standards that are currently in place not being enforced. As Kalpona Akter, executive director of the Bangladesh Center for Worker Solidarity, told Democracy Now!, Bangladesh “already has some rules and regulations for safety,” with which some politically powerful owners are not complying.
Maha Rafi Atal at the (UK) Guardian tries to walk a middle ground of increased safety but continued employment for Bangladeshi workers:

that should be about making a distinction between wages, which do not have to be the same everywhere, and workers’ rights, which should.

It may look on the surface like Yglesias is being all ‘realist’ and ‘sensible’, but in fact he gets the economics wrong. He forgets three things:
  • preferences are only half the story. The other half is the choice space in which preference can be expressed. It is the combination of preferences and available options that lead to the choices made. Ascribing the choices to preferences alone gets the theory wrong; one can just as legitimately point to the limited options
  • the market theory that Yglesias uses to underpin his ideas — that there are market transactions deciding the prices of garments and safety — assumes freely available and perfect information. A large economic literature then explores the impact of relaxing that assumption. But that’s the post-grad course, and Yglesias is stuck in 101. Here’s the thing: we could make it perfectly obvious to Western consumers how their garments were made, what the working conditions were. Then we could talk about a market solution. Let me put it another way: is Burger King going to launch a horse-burger because people were buying them before they found out what was in them?
  • supply and demand do not exist outside the institutions that help shape the economy. An analysis that doesn’t account for politicians who can override police edicts and flout safety regulations is incomplete. We should recognise that, for example, agreements and regulations help set the conditions in which the market is operating. So, there are trade agreements around clothing that promote its production in poor countries, but much less international recognition of professional qualifications for doctors, lawyers, accountants, etc. (On that front, economics is like the Wild West — anyone can hang out a shingle.) It is at best disingenuous to throw your hands up and say

in a free society it’s good that different people are able to make different choices on the risk–reward spectrum.

In a free society, it’s also good that people can express different opinions. Even when they haven’t got a clue what they’re talking about.

How do we teach this?

15/02/2013 § 10 Comments

Reading through the post-mortems of the financial crisis, I’ve been struck by something. The behaviour of the finance sector doesn’t fit the standard economics model, the Samuelson textbook depiction, or the Heckscher–Ohlin model of trade, or the Solow model, or any of the other bog-standard depictions of the economic system that we like to teach.

A key idea is that capital is a factor of production, like labour, land, and maybe entrepreneurship, management, natural resources, human capital, or any of the other factors people like to add. Two things about this capital:

  • capital gets a return for its use, which accrues to the owner of said capital, and
  • owners (capitalists, entrepreneurs, whatever) receive a return commensurate with the risk they take: higher returns are required to entice people to take greater risks (and thereby promote innovation).

But, but, but…that’s not what’s happened.

If you read the accounts of the financial crisis, two things are clear:

1. The people administering the mortgage-backed securities (MBSs) are having a hard time proving they own the mortgaged they say they do. To quote Adam Levitin:

The mortgage foreclosure process is beset by a variety of problems.  These range from procedural defects (including, but not limited to robosigning) to outright counterfeiting of documents to questions about the validity of private-label mortgage securitizations that could mean that these mortgage-backed securities are not actually backed by any mortgages whatsoever.  While the extent of these problems is unknown at present, the evidence is mounting that it is not limited to one-off cases, but that there may be pervasive defects throughout the foreclosure and securitization processes.

That is, these folks aren’t sure of what they own, and yet they are selling derivatives based on what they think they might have. More frighteningly, banks are taking or selling houses they don’t own.

2. Risk and reward are now de-coupled. Companies in the finance sector took gambles on the housing market, and things didn’t go their way. That happens. An evolutionary account of the market economy is that success should be rewarded and failure should lead to extinction. AIG, just to name one company, took massive risk onto its books by insuring the value of MBSs. Their clients claimed against the policies, which was going to drive AIG into bankruptcy. AIG got bailed out, as did a number of other financial firms. So, for finance firms, success is rewarded but so was failure.

Thomas Baxter, Jr., New York Fed:

In the months leading up to early November 2008, AIG had been actively engaged in efforts to negotiate tear-ups of its CDS contracts with its counterparties. AIG was completely unsuccessful. The need for the tear-ups was real; AIG was effectively hemorrhaging cash.

But what happened? Wall Street posted record profits in 2009 and had its fourth-most-profitable year in 2010, after it ‘benefited from a series of federal bailouts as well as low interest rates’.

Why aren’t more economists having a crisis of faith? The story and the models that we use to talk about the economy appear flawed in a fundamental way. It isn’t about innovation and efficiency, the supply side responding to signals from the demand side. Instead, fraud, crime, and collusion seem to be the path to riches.

Risk doesn’t just disappear

08/11/2012 § 2 Comments

The Pike River Mine report has brought the issue of risk and companies’ duties back up. The report found that the company exposed the workers to unacceptable risk. There is a very important discussion to have about ex ante and ex post perceptions of risk — Monday morning quarterbacking, to use an American phrase — but I won’t do that now. Instead, I want to focus on risk allocation and companies.

These things are called limited liability company (LLC) for a good reason. They limit the liability — the responsibility for failure. The company is a legal entity separate from its shareholders, and it bears its own risk. Shareholders can lose only their investments and no more.

This has proven a useful arrangement in the modern economy. If you try something out — a new product, a new store, a new technology — you can limit your losses. We have all benefited from this. The arrangement has encouraged risk-taking and innovation, and has helped create the material world in which we are living (cue Madonna?).

But, these things aren’t perfect.

Think of it this way. There is a distribution of uncertain outcomes. We can model this as the probabilities of good and bad outcomes. Let’s say that the following graph shows the probabilities of success. There’s a reasonable probability that things will go well and you’ll make money and so one. But, there is also a positive probability that you won’t succeed. Let’s say the black line marks the difference between business success and failure. The LLC allows you to truncate the distribution of outcomes that concern you; you get to lop off the left tail.

But, there is also a non-trivial probability that things will go horribly wrong. That’s what happened with the Pike Rive Mine. Think of these situations as the tail to the left of the red line. They won’t happen often, but they will happen. The probability doesn’t disappear. The LLC structure just moves the risk from the business onto other people.

We all benefit from this legal fiction, because of a more innovative and productive economy. On the other hand, some benefit more than others. That suggests a two-prong approach to dealing with this imperfection in LLCs:

  1. when a few people bear the burden of the rare disasters, they should get help from the rest of us. After all, they have ended up in the left tail while the rest of us enjoy the bulk of the probability distribution
  2. those who benefit more — those who chop off more of the left tail than the rest of us — should pay for the privilege.

There’s not much concrete policy in those ideas, but I’m sure we can work it out later.

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