Economics & Finance

Job Killing Regulations

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The President of the United States presides over a government that employs a huge number of people who write regulations that either slow down job creation or are actual job killers. In these times of high unemployment, the President could, by executive order, instruct these employees to use their existing discretion in favor of the interpretation that would save or create the most jobs.

There would be no need to wait for the Congress. There would be no need to spend the public’s money on this initiative. This executive order would be entirely ‘shovel ready’ and its impact on the deficit is overwhelmingly likely to be positive. So far as I know, President Obama has not signed such an order, nor has he given any evidence that he is even considering it.

Why?

Fat Tails

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From a WSJ column:

To be fair, the Orszags and Mr. Stiglitz acknowledged that “the extremely rare events located in the tail of a distribution are often quite difficult to analyze accurately.” Even so, they noted that White House budget gnomes had tested Fan and Fred’s capital against “the financial and economic conditions of the Great Depression.” The result: “[G]iven 1990 levels of capital, both Fannie Mae and Freddie Mac had sufficient capital to survive.”
 
[…]
 
The crucial point is that assessing systemic risk is difficult to impossible—and the likelihood of coming to a reliable consensus about it is even lower. Both Orszags and Mr. Stiglitz were officials in the Clinton Administration and saw the debates about Fan and Fred that the Clinton Treasury began in the late 1990s, only to get clobbered by the companies’ lobbying machine. Yet the three amigos still saw fit to put their names to a paper dismissing any risk of failure.
 
Why should anyone think that regulators—or economists—will predict the next systemic debacle any better? We only know better about the past. When the next problem erupts, as in 2002, smart people will be on both sides of the argument. And when large, systemically important companies are threatened with curbs on their business, they will pay Nobel laureates to write studies that explain away the dangers, and hire lobbyists to block any reform. A future Treasury secretary may also dismiss critics of a future Fannie Mae, or Goldman Sachs, as “ideologues,” as Hank Paulson did in 2007-2008.
 
The very existence of a systemic risk regulator, or council of regulators, will assist the largest and riskiest firms by creating an illusion of stability in a world made less stable by the implicit guarantee that this regulator would convey. It would be an accident waiting to happen, and one made inevitable by the institution created to prevent it.

Clever people rationalizing away risk destroyed Long Term Capital Management and countless other leveraged financial businesses. (As the column suggests, the incentives facing bureaucrats and politicians make this problem even more acute for government-managed enterprises.) The idea is generally: we’ve looked at all the angles and done simulations and the odds of a ruinous meltdown are so small we’re not going to worry about it. The problem is that the models used to estimate risk are sensitive to errors in the assumptions. That’s what “extremely rare events located in the tail of a distribution are often quite difficult to analyze accurately” means. If the distribution is statistically abnormal the tails of the distribution might be fatter than you think, in which case those extremely rare events might not be so rare. For businesses that deal with statistically normal returns distributions, such as casinos and life-insurance companies, the risks are relatively easy to determine. Those are well understood businesses with almost no risk of failure as long as they are well capitalized and well managed. By comparison, the risks for a highly leveraged negative-gamma financial scheme are much more difficult to pin down. Fannie Mae was essentially a colossal short-put position on the mortgage industry. Was the risk of ruin 1 in 1,000,000 or one in a hundred? Who knows. A cursory look at the history of financial debacles suggests that such events happen much more frequently than many models have predicted. A reasonable person with extensive private-sector financial experience as a trader or fund manager would know better than to bet the ranch on the accuracy of a model whose worst-case outcomes involve unknown probability of unbounded loss. More likely he would want to be on the other side of that trade. Yet Congress jumped right in and kept doubling down when it should have been cutting its losses, and is now repeating the error with the FHA. Orszag and Stiglitz apparently didn’t understand this back in the day. Do they understand it now?

When people like these are in business and miscalculate they go out of business. If they’re lucky they then get to go to work for someone who has a better understanding of risk than they did. But when they’re in government and miscalculate they may pay no penalty or even be promoted, and the risks they rationalize may be ignored until institutions fail. I don’t mean to single out Orszag and Stiglitz, who probably meant well and were not responsible for Fannie Mae (Congress was). But the public sector is full of such people, and as the government expands they become more influential and their mistakes become more costly.

Holiday Book Ideas — Four That Are Good to Go

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I’m late, late, incredibly late on four books that authors gave me to review. That doesn’t mean that I can’t give credit where credit’s due … in plenty of time for the book-buying frenzy before the holidays. With luck, I’ll finish off the full reviews in December but since *I’m* buying copies of these books for friends and family, maybe one or more of them might fit someone on your list. All recommended for the categories of people headlined.

Economists, Physicists, History of Science buffs

Newton and the Counterfeiter describes Isaac Newton’s multi-year battle with one of London’s most successful counterfeiters. No surprise who wins in the end, but it is surprising how well Levenson provides background on the protagonists … without overwhelming the reader. Recommended for students or professionals with an interest in the history of money, finance, or just a fascination with what the great Newton did after he polished off the Principia. The counterfeiter’s “colourful” life precludes giving this book to a pre-teen but all others will find it, like the earlier-reviewed The Ghost Map, a fascinating snapshot of life in London.

Japanophiles, Asian culture fans, World History Buffs

I’m years late on this one but Through the Looking Glass is highly recommended for anyone wondering how Japan ended up with such a different culture … and why their adoption of Western technology at a breakneck pace in the late 19th century was so successful. Thought-provoking and such a good summary of Japanese culture that I’ve struggled for over 50 hours to epitomize in writing what the author has written in hopes of getting a full book review out the door. I’ve failed, but I’ve also bought more than a half-dozen copies of this book for friends on two continents with an interest in Asian culture.

Entrepreneurs, Fortune 500 cube jockeys, Economics students, Anglosphere buffs

Free: The Future of a Radical Price by Wired Editor-in-Chief Chris Anderson picks up where his Long Tail finished. The halving of computation, bandwidth, and data storage costs each year has made a new generation of businesses financially feasible. The freemium service (like Flickr, LinkedIn, Facebook, etc.) where basic services are free and a small set of customers pay for additional features, has become so common that it is now unremarkable. Anderson looks at the history of the word, the different definitions of free in the context of culture and business, and the gap in the academic literature in understanding the new generation of businesses that leverage “free” in profound ways. My book review will, like my earlier review of Long Tail, look at why the Anglosphere has been the source of so much “free” over the last couple of centuries and why it leads the way in both charitable and profitable businesses that leverage the idea. A “must have” for anyone thinking of starting a business. People under 30 will think “d’uh” but Anderson still offers a lot of context and some very good background on the history of “free” in business in the 20th century for younger readers. And a fun, even revolutionary, read. I’m buying copies for nieces and friends with an interest in media.

Ambitious NCOs, Military Officers, World History buffs, Prognosticators of the American future

Empires of the Silk Road: A History of Central Eurasia from the Bronze Age to the Present is a grand summary of the culture of the steppes, from the time of the domestication of the horse and the appearance of lactose-tolerant humans (see 10,000 Year Explosion), to the 21st century suppression of the Chechens, Tibetans, and Uighurs. A fascinating source book on the ebb and flow of culture across the “ocean of grass” and the firm focus these cultures had on trading with the great empires on their periphery. Trade with us … or die. Most of these cultures, and the direct influence they had on world history, has been largely unknown except to a handful of scholars. In Empires, the author brings all this background information together in one place, draws on the most modern scholarship in linguistics, history, and archaeology, and provides a ground-breaking introduction to the general public. The striking parallels with the European nations that built empires based on liquid oceans becomes clear only by the end of the book … as is the tentative nature of Russia and China’s hold on the vast interior steppe (triggered by the introduction of firearms, and only solidified in the final massacres of the Junghars by Qing China in the mid-18th century). Anyone with an interest in Russia, the Middle East, or China will learn a great deal about the role of the Central Asian Culture complex on these areas in the last 4,000 years. Nowadays, military folk posted to the ‘Stans or places like Mongolia will find this book invaluable … firstly as a brisk introduction to the cultural roots of the place, and secondly as a reference book to read and re-read in future years to grasp “the big picture.” If you have friends or family that are ambitious for learning about the continent (let alone the region), start them off at the beginning. Anyone senior to Captain should buy this book simply to have it ready when needed. Because it will be needed. You can’t understand the Chinese and Russians without understanding the “enemy” they faced for centuries and the echoes that continue in their territorial obsessions. Highly, highly recommended. My full review will comment on the author’s more personal assessments but his account of Central Asian history is a entirely straight-forward, well referenced, and real service to the English-speaking public. I’ve bought copies, again, for friends in Europe and North America.

The Public-Health Fallacy

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The discussion at this otherwise-good Instapundit post is typical.

The discussion is misframed. The question isn’t whether a specific medical procedure is a good idea. The question is who gets to make the decisions.

This is a comment that I left on a recent Neo-Neocon post:

It’s the public-health fallacy, the confusion (perhaps willful, on the part of socialized-medicine proponents) between population outcomes and individual outcomes. Do you know how expensive that mammogram would be if every woman had one? The implication is that individuals should make decisions based on averages, the greatest good for the greatest number.
 
The better question is, who gets to decide. The more free the system, the more that individuals can weigh their own costs and benefits and make their own decisions. The more centralized the system, the more that one size must fit all — someone else makes your decisions for you according to his criteria rather than yours.
 
In a free system you can have fewer mammograms and save money or you can have more mammograms and reduce your risk. Choice. In a government system, someone like Kathleen Sebelius will make your decision for you, and probably not with your individual welfare as her main consideration.

Even in utilitarian terms — the greatest good for the greatest number — governmental monopolies only maximize economic welfare if the alternative system is unavoidably burdened with free-rider issues. This is why national defense is probably best handled as a governmental monopoly: on an individual basis people benefit as much if they don’t pay their share for the system as if they do. But medicine is not so burdened, because despite economic externalities under the current system (if I don’t pay for my treatment its cost will be shifted to paying customers) there is no reason why the market for insurance and medical services can’t work like any other market, since medical customers have strong individual incentive to get the best treatment and (in a well-designed pricing system) value for their money. The problems of the current medical system are mostly artifacts of third-party payment and over-regulation, and would diminish if we changed the system to put control over spending decisions back into the hands of patients. The current Democratic proposal is a move in the opposite direction.

Real Medical Innovation, and Closed Systems

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One of the biggest follies in the health care legislation is assuming that America is a “captive system” or a “closed system”. In these sorts of models (probably Hawaii is a good example) you can implement change and individuals don’t have a lot of choices and thus fees or taxes can be used to subsidize wholesale change.

The truth is much more complex; individuals are intelligent, many choices exist, and people respond to incentives. In addition, companies and even entire countries take different approaches to profit from opportunities that arise from these sorts of captive assumptions.

This article from the Wall Street Journal titled “The Henry Ford of Heart Surgery” analyzes a company in India that is pioneering economies of scale in heart surgery by 1) building huge facilities, 2) focusing on reducing all costs throughout the system from medical equipment to sutures, 3) hiring surgeons and having them perform the same types of complex surgery over and over to become experts on that specific task and 4) changing the hours of use and of doctors so that expensive medical equipment has a higher utilization rate which reduces the average cost / use.

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