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Migration, history and countries as club goods

By Lorenzo

This is based on comments I made here and here.

Thin conceptions
There is a line of argument which holds that if free trade in goods and services is good for economies, if free trade in capital is good for economies, then surely free trade in labour would also be good for economies. So, just as one should have open access for goods, services and capital, one should also have it for labour. Thus, migration should not be hindered. It is basically a “maximise the gains from trade” argument.

There is a related line of argument which holds that free trade in labour would result in net improvement in the overall human condition, so should be permitted. It is much the same as the previous argument, except that there is no implied preference for existing residents of a given territory–an unbounded “maximise the gains from trade” argument.

A more robust moral argument is that open borders represents acceptance of the primacy of personal liberty. People should simply be free to live where they want.

All these arguments ultimately rest on very thin (indeed, literally incredibly thin) conceptions of society and human interactions. People are treated as completely interchangeable economic agents without histories, collective preferences or issues of loyalty and affinity. Polities are treated as utilitarian service providers. It is a world literally without history. These arguments have almost no popular resonance for exactly those reasons–that people have far “thicker” conceptions of themselves, their societies and their polities than are acknowledged in the framings on which the above arguments rest.

Thicker concerns
Looking at dysfunctional polities (of which there are many) provides a salutary corrective. Indeed, open borders libertarianism suffers from the revealing irony that libertarians typically bemoan the insufficient commitment to liberty of the freest societies on the planet but completely fail to notice how unusual any such commitment is among contemporary or historical polities. Or draw any conclusions from same. It is as if the structures and habits which create free societies are taken to magically descend on folk, rather than being painful historical evolutions.

It is true: the case against open borders is based on failing to treat people as if they were goods, services or capital because they are very much more than that. As are the connections between them.

Goods and capital don’t vote, they don’t commit crimes, they do not serve in the protection of others, they do not fight, they do not create (or destroy) communities. (Though they can be tools, instruments, for all these things.)

A society is much more than a set of transactions, a set of potential gains from trade. And migration policies change societies in all sorts of ways. For example, a society which is largely monocultural can manage much denser policy structures than a more diverse society. While migration creates costs within the host society which are not evenly distributed. Costs which are profoundly affected by who migrates, in what numbers and where.

Migration can also be a weapon of one group against another. Hence the so-called Curley Effect (pdf)–using migration to attract in folk likely to vote in a particular way and the results to drive away folk who vote differently.

Nick Rowe has posted on his excellent way of teaching comparative advantage. But if one adds in issues with costs of communications and different expectations across language, cultural and religious groups, it hardly works quite as smoothly. Especially if there is geographic clumping. Adding in history, in other words, shift the analysis some.

Policy variance
Immigration can be handled more or less well. Australia handles migration comparatively well and has a very high rate of foreign-born residents by Western standards (around 28%)–for example, migrants to Australia actually do better in school on average than locally-born, which is not a normal pattern. But Australia is a prosperous, English-speaking island-continent, so border enforcement is relatively easy and we can cherry-pick migrants (which we do quite effectively).

Australia also has diverse migrants, which helps greatly. Indeed, the most problematic migrant community are Lebanese Muslims in Sydney because:

(1) Sydney is Australia’s least socially-functional metropolis.

(2) Unlike Maronite Lebanese, they do not plug straight into well-established Catholic networks.

(3) They were brought in an unusually large “lump” with minimal selection procedures.

(4) There are specific issues for Middle East Muslims settling into Western countries.

The US has much less difficulty with Muslim migrants than Europe does because the US is set up as a settler country, its migrants are relatively diverse, its Muslim migrants are generally better educated, “God-discourse” is much more conventional part of public life while organising through your local mosque just replicates established patterns of organising through your local synagogue or church.

Varying experience
In Australia, opinion polling had become somewhat hostile to migration since the mid 1970s. The polls improved dramatically after the Howard Government (1996-2007) made a big play of “stopping the boats”, despite running a considerable migration program, the least Eurocentric in Australia’s history up to that time. The Government’s slogan of “we will decide who will come here” seriously resonated. The costs and benefits of migration are not evenly distributed, and giving voters a sense they have no say or control is not healthy. It is that sense of powerlessness which is surely a very big driver of popular responses.

Locally-born Americans

In Without Consent or Contract Robert Fogel documents the significantly adverse effects of mass migration on locally born US citizens during the C19th. The nativist movement expressed rational antipathy to mass migration. The new Republican Party brilliantly finessed that into antipathy to “the Slave Power”.  Access to resources for existing residents can be reduced by migration–this is what happened in C19th US, for example. The dysfunctional EU labour markets also share some of such features. Another way in which the “it is just about gains from trade” analysis does not work.

The sense that your rights will be under threat if a particular group gets sizable is another factor. Mass migration of Muslims into a society (or even developing world Christians) might not be good for the freedom of queer citizens. So queer folk are not likely to be keen on large scale Muslim migration, especially if the fight for equal protection of the law is not yet fully won or is otherwise precarious. Polities make rules, migrants become voters and vote. It makes a difference.

We have to take into account peoples real world preferences. The Rawlsian (behind the veil of ignorance) analysis is both not applicable and instructive. Over the longer term, the game of migration policy is about the rules as much as anything else, where rules are openly up for grabs and preferences about rules are not the same as preferences within individual transactions.

Hence, part of the “thicker” concept of country is that it is not just a mass of one-off transactions. Not even the concept of repeated transactions allows trade analysis to be “deep” enough. The rules and affinities powerfully affect not only which transactions take place, but their content and effects.

Since polities need to be able to claim the loyalty of citizens (not being able to do so is not a survival trait in a polity) and as political entrepreneurs exist (see the recent EU elections) telling large numbers of citizens that their preferences on entry to their country have no standing, no matter how important it is to them, is not conducive to political or social stability.

Increased communication costs and dispersal in preferences also affect what public policies become more or less viable. The “Scandinavian model” in public policy fairly clearly rests on high levels of communication and shared preferences. The more migration reduces such flows of communication and disperses the range of preferences, the less viable the Scandinavian model becomes. As that becomes clearer, the costs of migration may well lead to rational antipathy to said migration.

Of course, pandering to anti-immigration feeling can have other political entrepreneurial uses. It may be a lot easier than, for example, dealing with dysfunctional labour markets. Even when said dysfunctions have a great deal to do with how dysfunctional the banlieue are, for example. Regulations tend to defend social incumbents (see dysfunctional labour markets): but well organised/politically focused incumbents rather than just any incumbents.

A defender of open borders on liberty ground can claim thatThe only question is whether you believe in liberty or not. It’s about principles. In fact, the debate is about how to conceptualise human interactions and what countries are. And yes, one can “win” a debate by simply ignoring or denying those parts of the social world which are awkward for one’s own case. But that is not going to be remotely persuasive to folk who are not up for that.

I do not find any sort of anarchism persuasive, for example, as (1) state societies have achieved so much more than non-state societies and (2) a lack of a state just creates a market niche for entries to the “state” market. That, after all, is what protection rackets are: competitors to the state in extraction-via-coercion.

Conversely, using the family as an analogy for country bothers me, as I feel some connection to fellow citizens, but not that intense a one. Moreover, talking about countries as being like families is a favourite rhetorical ploy of socialists, nationalists and fascists, so has uncongenial, even dangerous, collectivist associations.

Polities as clubs
A way to think of polities in economic terms is that they are a uber-club good. A way of providing public goods. They are not fully voluntary associations, because one is born into a polity, so membership is partly “by blood”. Which makes them territorial clubs (a bit like gated communities).

The effect of new entrants on the rules is another way polities are club-like. And there are a reason clubs have membership rules and rights to exclude. Clubs want people to “fit in”, not be disruptive, hopefully be active in supporting the activities of the club.

Of course, border control can have its ugly aspects. And making unapproved migration illegal without sufficiently effective border control creates a population of “illegals” who, being isolated from normal legal protections, become vulnerable to exploitation, even labour bondage and slavery. Nevertheless, managing a successful polity is a more precarious enterprise than supporters of “let anyone in” seem to understand.

Thinking of a polity as a device for making political bargains, large and small, if anything increases the power of the club analogy. If group X rejects group Y as someone to make deals with, this is deeply disruptive to making bargains. (See Sunni and Shia in Iraq; Protestants and Catholics in Ulster.) The greater the entrenched associations of common loyalties, the more somewhat antagonistic diversity can be dealt with. The Catholic v Protestant fights in Australia could be managed through a mixture of past Britishness and future Australian aspirations. The Ulster divisions were so entrenched because which polity they should be part of was precisely what was in dispute, while “Iraq” clearly has little standing except as a useful device for whichever group is in control of the state apparatus to repress the other(s).

History matters. Really, it does. Which is why the argument for simply open borders both fails to resonate with the wider public and simply fails. It just does not take history, the requirements of effective politics or the depth of human interactions seriously enough.

The evolution of social bargains — operative not normative

By Lorenzo

I was reading Yoram Barzel‘s property rights analysis (pdf) of the rise of Parliamentary government in England, when the full force of his critique of normative concepts of the rise of parliamentarianism and representative government hit me.

That Iraq is busily messily falling apart, following on from–and partly a consequence of–Syria doing so, with the advance of the Islamic State of Iraq and Levant, (vindicating the long-ago analysis of T E Lawrence) helped the penny-drop moment.

If we, building on Charles Tilly‘s seminal Coercion, Capital and European States and recent scholarship in economic history (notably the LSE’s economic history working papers), take the crucial element in the rise of the West as being the develop of what might be called the active bargaining state, then it is a great error to see it as the operation of some normative-driven process, some Hegelian necessity working behind history to realise some culminating outcome. (Active bargaining state as even the most autocratic states from the past represented implicit or passive social bargains: the active bargaining state coming in both direct–Parliamentary–and indirect–authoritarian–forms, with ancien regime France being an unstable mixture of the two.)

Norms evolve
The normative approach is an error of historical understanding at two levels. First, because the norms evolve along with the evolution of the bargaining state. The barons at Runnymede in 1215 (Tammany Hall in chain mail, as H Beam Piper called them) lived in a different normative universe than the participants in the Glorious Revolution of 1688 who themselves lived in a different normative universe than those arguing over votes for women in the late C19th and early C20th. If acceptance of the norms of representative democracy as they currently operate in the West is necessary to establish an active bargaining state elsewhere, then the enterprise is doomed. Those norms are the result of very particular histories and experiences.

If, however, the exercise is an operative (i.e. about trade-offs that work for the society in question), rather than a normative, one, then we can be much more hopeful.

Just as Britain tried to export the Glorious Revolution to Mesopotamia and the Hindu Kush, so the US has tried to export the American Revolution to the same places. But both the Glorious and American Revolutions were the product of very specific historical circumstances–as the adherents thereof well recognised at the time. Even such a revolutionary firebrand as Patrick Henry grounded his most famous Revolutionary speech in specifically British traditions.

Evolving trade-offs
Traditions which are too often read from now backwards, instead from then forwards. Hence the second error–not understanding the operative nature of the process and the evolving bargains.

Yoram Barzel’s point is that it the process of the growth of Parliamentary government should not be understood as one long wresting of power from royal clutches, but as process where monarchs often engaged in trade-offs that were very much in their interests. It is easy enough to point to King John being dictated to at Runnymede, the military defeat and execution of Charles I, the overthrow of James II but what these rulers had in common is that you could not make a deal with them. In the case of John and Charles I because they could never be trusted to keep to any agreement and James II because he was fixated on an outcome that was anathema to the bulk of the British political nation.

Runnymede 1215, a reluctant signatory to posthumously enduring bargain.

Magna Carta stuck because it was re-issued under Henry III and by Edward ISimon de Montfort‘s innovative parliament stuck because Edward I saw it as an effective tool of governance. Indeed, the pioneer of summoning elected merchant representatives was a king–Alfonso IX of Leon & Galicia. The Glorious Revolution stuck because William III and Mary II could see a good deal when offered to them. And while these spectacular landmarks of history generate nice dramatic set-pieces, Barzel points out that the history of the growth of Parliamentary government and rule of law was much more a steady evolution, an evolving series of trade-offs, where rulers gained by giving folk a say.

A point that Barzel does not consider much, is that such forums also provided very useful information sources for monarchs. It gave them a way of checking up on their own agents (a helpful monitoring service) and of ensuring they were in touch with the concerns of people who mattered. Even from this distance, it is fairly clear that Edward I was concerned that he not lose touch with the concerns of the powerful–of the wider political nation–in the way his father had and saw in Simon de Montfort’s parliamentary innovations a useful way of doing precisely that.

East Asian contrasts
A nice social bargaining contrast is provided by comparing China and Japan as they confronted the Western challenge during the C19th. The great difference between Qing China and Japan in confronting said challenge, was that under the Song, the Ming and the Qing, China had been ruled by thin meritocratic official layer. There was a clear, very passive, social bargain–the state upheld family authority and provided minimal public goods, taxing relatively lightly, while families did not make trouble. Since the only lever the Emperors had to control their officials was command-and-control, the system was prone to decay into corruption and the dissipating of central control.

Official in a one-track system.

This was somewhat like what happened to the command economies, though they fell apart rather more speedily (given each of the the above three dynasties of mandarin China lasted over 260 years), as the greater technological capacity of the modern command economies was not enough to compensate for the much more overweening attempt to command-and-control everything. Of course, if you regard Mao as the First-Emperor-with-a-telephone, Mao’s attempt did last longer than said Emperor’s regime (as the Qin dynasty only lasted 15 years) with Deng and his heirs subsequently trying to be the new Han. (I.e. the much longer lasting dynasty as result of taking the overweening elements out of what the Qin Shi Huang had created.)

Not only was the Qing dynasty already well into its decay phase as the Western challenge became more urgent, China possessed no mechanisms for more active social bargaining, no real precedent for such, not even the political vocabulary for it. (That the Qing was a foreign dynasty was a complication, but when was the last time England had an English dynasty? The Tudors were Welsh, the Stuarts Scot, the Hanoverians/Coburgs/Windsors German, the Plantagenets French, the House of Rollo Danish. Even the House of Wessex were invaders, if you go back far enough.)

Provincial ruler among competitive jurisdictions.

Japan was in a very different situation. Social bargaining was built into its political structures, both active and competitively passive (between daimyos). It was much easier for Japan to add on to already existing institutions and patterns more formal structures for social bargaining adapted from the West and develop a modernising social bargain able to rise to the Western challenge than it was for a China where any such habits and structures had to be built from scratch.

Back to the Middle East
The problem with Iraq is that it might be able to work as part of a larger empire, but it makes no sense as a nation. (A state which needs someone like Saddam Hussein to hold it together is one not worth keeping.) It was a cobbled-together imperial deal, lumping together three (separately administered) Ottoman vilayets (a Kurdish one, a Sunni Arab one and a Shiite Arab one) into one state. While the recent American adventures there represent the US, yet again, trying (with not much success) to deal with the backwash of European imperialism, it also represents the triumph of the normative over the operative.

The Republic of Somaliland shows what can be created by a genuinely locally-driven arrangement. It is governed by a universal suffrage House of Representatives and a House of Elders, made up of traditional leaders. In other words, their very own House of Lords. Because that reflects how their society operates.

House of Elders

Both Iraq and Afghanistan would have had, or have, more chance of stable futures if their legislatures were more grounded in their social realities. But, of course, the Americans would never consider having some local House of Lords equivalent, because that would require too much knowledge of their own deeper history and be too confronting to their evolved norms.

Nevertheless, the trick is to sell a workable bargain, a useful set of trade-offs. Not some pre-set normative wish-list from a quite different tradition.

Part of the problem being that you have to see other folk as people to bargain with. The Iraqi PM clearly did not see the Sunni in such a way, and is now reaping the consequences. Just as using ethnic membership as an indicator of loyalty can reduce coup possibilities while increasing the likelihood of civil war.

Indeed, it is a depressing principle of contemporary Middle Eastern politics that any minority that does not control its own state or quasi-state gets oppressed. (Hence the Alawites and their minority allies fighting so hard not to lose control of the Syrian state to the Sunni majority.)

That the jihadis reject any notion of the social bargaining state (which may also make them, including in the form of ISIS, less than durable in their local control) makes the need to have socially-and-locally grounded bargaining all the more urgent. Even if some negotiated settlement is (eventually) a likely outcome. But the Iraqi implosion also points to the fact that Europe’s boundaries evolved over centuries, and even now are less than a perfect fit. The Middle East and Africa are dealing with state boundaries that often did not evolve locally at all, but were imposed by outside imperial powers.

The last time the US did a good job of occupying a major country effectively on its own was Japan, and there it had much more similar social material to work with a pro-consul from a family with experience of colonial governance.

The Bush Administration clearly did not think through the genuine difficulties and constraints of Iraq–having too little sense of history and too much American presumption of omnipotence. (Attempts to blame the present situation in Iraq on President Obama are particularly pathetic: though one may well make other criticisms of his Middle Eastern policies, which display a similar inability to think things through.) But the sui generis nature of American historical evolution makes for a poor set of framings from which to understand other societies.

Yes, dividing Iraq was diplomatically fraught, but it is now the likely outcome anyway–or, at least, a very decentralised state–and in much less Western-friendly terms than a deliberately organised divorce would have been. While having some House of Lords equivalent–or equivalents–could have been a very useful way to work through existing social structures and to encourage bargaining that operated according to the contours of the societies in question.

Conversely, the analytical humility required for a better effort would have militated against making the attempt in the first place. Such analytical humility would include taking religious motives seriously–but that is a perennial failure of contemporary Western analysis.

It is revealing that the one part of post-intervention Iraq which is a clear success–Kurdistan–is also the one part with a clear identity where local forces had already evolved workable local bargains. This is the example that could have been built on (and should still be supported). But so building would also have required a strong sense of locality and history. (Of course, hindsight is always 20×20, but that is the fun of historical analysis …)

Perhaps also the notion of instant solutions needs to be abandoned. The open and democratic societies of the West took a long time to evolve. In the longer view, perhaps the overthrow of Saddam has allowed underlying forces to, however brutally at times, work themselves towards social and political equilibriums which do not require rule by the most successful psychopath.


ADDENDA Nice comment about clans and consensus. Nepotistic societies work on different time horizons and need processes that respect that.

Revolutionary divides

By Lorenzo

It is in the nature of successful revolutions (successful in the sense of imposing a new political order which persists) to divide their society. They represent a political bargain implemented by force. Those against whom such force was applied are not participants in the revolutionary bargain, they have it imposed on them.

The Glorious Revolution, the American Revolution and the French Revolution all had this effect. The alienated from the Glorious Revolution were the Jacobites, from the American Revolution were the Tories and from the French Revolution throne-and-altar France.

Absent, faded or enduring

Of the three Revolutionary regimes, the American revolutionary republic was by far the most ruthlessly successful in dealing with the said divide. The American Tories were expelled and their property confiscated. (The American Revolution generated more refugees than did the French Revolution.) Thereafter, there may have been arguments about the implications of the Revolution (in a sense, Americans have argued about little else since) but being in favour of the Revolution itself (even if not quite the same Revolution was being conceived) has been the overwhelming social consensus. Hence the US Constitution–the embodiment of said consensus Revolution–being the icon it is. Given that migrants went to the US precisely because it was the polity that the Revolution created, they have not disturbed that social consensus or the Constitution’s iconic status. (If anything, they have reinforced it.)

The political order established by Glorious Revolution was not in a position to simply expel all supporters of the deposed King James and had to endure various Celtic fringe revolts for decades after. Indeed, the last, 1745, was the biggest and most threatening. One could say that Catholic Ireland was never fully reconciled to the new order, but as it had never been fully reconciled to any English dominated order, that is not really a case of a revolutionary divide. (Of course, one could also argue the failure to incorporate Catholic Ireland as a participant in the new political order entrenched Irish alienation.)

In the end, the passage of time won, more or less. The Revolutionary political bargain was broad enough, and flexible enough, to expand to encompass the previously disenfranchised. Though the harrowing of the Highlands after the disaster at Culloden (1746) was the iron fist which blocked off alternatives. To claim that the contemporary push for Scottish independence represents a continuing divide over the Glorious Revolution seems an excessively long bow, since even the pro-independence Scots want to continue along the broad constitutional path the Revolution established. They are about reversing the Act of Union (1707), not the Revolutionary settlement.

The French Revolution is a complex case. There was fairly clearly a resurgence of the Revolution-alienated in the radical right politics of the 1930s, for example, and in the Vichy regime. A resurgence one could reasonable argue has re-manifested in the electoral prominence of the Front National today. The politics of the guillotine made the French Revolution far more elite fratricidal than either the American or Glorious Revolutions, while the brutality of the suppression of the Vendee also has no real counterpart in either the Glorious or American Revolutions. So France remains a country where the divide over its Revolution remains a much more live issue than in the UK or the US. That the French Revolution was not able to create a stable political order (again, unlike the American or Glorious Revolutions)–France currently being on its Fifth Republic, having also had two Empires and three Monarchies since the Revolution–also points to a more divided society.

Sui generis framing

That the US Revolutionary order became functionally consensual so early may distort American perspectives. Certainly, they had their own Civil War, but that can be put in the slavery box. Either way, it was not a revolt against the Revolutionary Order as such, but a fight over its implications. The Confederate Constitution was, after all, just a tweaking of the US Constitution, with the tweakings being very much about slavery.

But Americans can look at their country, one that was always ethnically mixed, see a common political (and to some extent social) enterprise agreed upon and a stable political order being created. The expulsion of the Tories gets written out of the story, the British legal and political heritage also gets somewhat written out (or taken for granted: that they were fortunate heirs of the Glorious Revolution is not much dwelled upon) and the Civil War becomes a heroic fight over a noble cause and a peculiar institution, enabling it to be put in a special historical box. So they can look at a country like Iraq and not consider how much they are treating a backwash of European imperialism as an inviolable entity. Not every political inheritance is a suitable basis for that workable social bargaining that makes for stable political orders.

Yes, the US Founding Fathers created (on the second try) an enduring political order, but they were dealing with populations who had already been through the selective process of migrating there in the first place as well as the experience of representative politics within the British colonies. Electoral social bargaining was already part of their operative experience in relatively egalitarian social settings (given Amerindians and slaves were not part of the political nation). As was the notion of some broad common enterprise.  American historical experience is fairly sui generis. It is a poor basis for thinking about societies with very different histories and structures. But moving outside American framings is both conceptually difficult and politically fraught. Yet, without such moving beyond American framings, American policy is going to continue to have a ham-fisted quality when dealing with very different societies and histories.

Memories of Ray Evans (1935-2014)

By Lorenzo

I was greatly saddened to learn, via email, of the death of Ray Evans.  I first met Ray sometime in the 1980s, when he was an indefatigable fighter for labour market reform. The attempt by the new Hawke Government, via the Hancock Report, to expand even further the legal privileges of the union movement inspired him to co-found the H R Nicholls Society.

It was typical Ray–to get politicians, business folk, academics, people with relevant experience to come together, to analyse, to inform and, above all, to not have the sense of being alone. Ray was a great opponent of the perennial modern tendency to try and declare debate closed and the holders of dissident opinions to be wicked.

As the Society’s website announces, the Society is in favour of minimal regulation of the labour market. More specifically, it seeks freedom of contract and association. Not to have special arrangements and special privileges entrenched in law. The Society itself was subject to ferocious denunciations from within the “Industrial Relations Club” (the IR Club), not least from those employer organisations who relied on selling their services as navigators of regulatory complexity. Said organisations were nowhere near as publicly and virulently vocal as the union and wider labour movement, but their hostile backgrounding of journalists against the Society helped to entrench the “extremist” tag.

Yet, looking back, the current regulatory structure of Australian labour markets have moved much more in the direction the Society advocated than its critics wanted. Labour market regulation still protect job incumbents against labour market outsiders, but a great deal less than used to be the case. Union privilege has been pared back somewhat. As the Australian and the Victorian Opposition Leaders both contemplate the embarrassments that the corrupt thuggery that so intensely tribal a culture as the union and labour movement is, alas, prone to, the case against said legal privileges looks even better.

Australia enjoys comparatively low unemployment (though not down to pre-1973 levels); the previous pattern of each round of the business cycle leaving unemployment higher than it was before has been broken. The biggest single factor in that was getting monetary policy mostly right, but the opening up of the labour market also played a role. The more regulations privilege insiders, the more folk are left on the outside (which is what unemployment is): a principle the entrenched high unemployment (particularly youth unemployment) of many European labour markets display.

Through it all, Ray Evans just kept going. He once described himself as a “defender of sound doctrine” and it was this combination of being certain in his own mind, coupled with a great appetite for knowledge, which he could deploy with great facility, that made him such a powerful advocate of ideas. He was also a much-travelled man, with great anecdotes about his travels. Such as being in Iceland when they were celebrating their great diplomatic success in blocking Australia’s election to the UN Security Council (they took umbrage at our anti-whaling policies) or Texans being completely puzzled by the notion of Government “releasing land” for housing.

But an advocate always on the lookout for the like-minded. You did not have to agree on everything, just be able and willing to contribute to the particular cause in hand. So, for example, he got Gough Whitlam to speak at a memorial for Bert Kelly, the “Modest Member”. Ray’s differences with Whitlam were manifold, but they agreed on free trade, and that was enough. (Trade protection is, of course, another form of legal privileging.)

Ray Evans was a defender of traditions and traditional belief who also treasured the dynamism of Western civilisation. His outlook tended towards the Burkian: Burke’s comment that:

When bad men combine, the good must associate; else they will fall one by one, an unpitied sacrifice in a contemptible struggle.

spoke powerfully to Ray, hence his founding of a series of advocacy societies and discussion forums, as Patrick Morgan sets out in his online obituary. Not a noted admirer of Keynes, Ray continually acted upon Keynes’s assertion that:

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.

One suspects that he would also have agreed with Keynes that:

I can be influenced by what seems to me to be justice and good sense; but the class war will find me on the side of the educated bourgeoisie.

Except that he would not have bought into the notion of a class war. Something his critics typically never understood is that he thought the IR Club was against the long term (and sometimes short term) interests of the workers as much as, in some ways more than, the interests of anyone else. Corralling workers into compulsory union coverage bred corrupt and complacent unions hostile to innovation. (Which is one point where I demur from Patrick Morgan’s obituary: Ray would never have agreed that workers should not be able to sue for breach of contract–that would just be a new form of legal privileging.)

It was always an error to too glibly pigeonhole Ray. This was brought home to me when he expressed admiration for Oliver Cromwell, describing him as a “great man”. Ray took a broad view of the heritage of the past and the possibilities of the future. He was very much against “blood-and-soil” notions, believing that liberty and salvation were possibilities open to all who embraced what they required.

The dynamism of Western civilisation is its most distinctive and enduring feature, creating constant conundrums for Western conservatives, hence a prudential liberal such as Edmund Burke becoming an icon of Anglosphere conservatism. Another way in which Ray followed Burke was his religion was a great anchor for him amidst the storm of debate and events. Contemporary trends within the Anglican communion distressed him. I am not surprised that, according to Patrick Morgan’s obituary, he contemplated moving to the new Anglican rite of the Catholic Church (“crossing the Rubicon“–going to Rome–as it is known), but also not surprised he never took the step. He was ultimately grounded in Anglosphere Protestant traditionalism and, however much he sought to encourage like-minded folk to discuss and debate and then, so fortified, contribute to the wider public debate, the Protestant notion of being naked before God spoke to him. He was very much a man looking forward to what future could be created, however grounded in the past he was.

We were never friends, simply associates. We disagreed on some obvious matters. But I always treasured the spaces he opened up for civilised discussion, debate, learning and sharing of experience. He had been physically frail for sometime, though his mind was as definite and active as ever.

He was a man who was very definitely there, you noticed Ray. He had strong sense of humour, with a hearty laugh. If you offered him a thought or significant fact he had not come across, a quizzical expression would cross his face as he considered what was offered. If he thought it was simply wrong, he would disagree vigorously, forcefully and knowledgeably.

Part of what made him so effective, is that he never felt any great need to take credit. The goal was the thing. Some years ago, a think tank he had not been involved in presented him with an award for his services to public debate. At the dinner, he gave a speech centring on how important St Augustine‘s ideas were for the development of Western political traditions, connecting the deep past to the present and prospects for the future. Including how important working class patriotism had been to the survival of the West. He finished, and simply left the podium. He had had his say, he left his audience to consider the ideas presented to them.

His death leads me with a sense of being bereft. But the sense of what is lost and gone is itself a tribute to the worthiness of the man who is no longer with us.

Why monetarist victory is necessary: so central banks cannot hide

By Lorenzo

A guest post at Marcus Nunes’s blog Historinhas (sans graphs).

In the debate about how to think about the Great Inflation of the 1970sMilton Friedman‘s policy advice–constant growth in a targeted monetary aggregate–turned out to be misplaced. Indeed, the failure of the Thatcher Government‘s monetary aggregate targeting led to the popularisation of Goodhart’s Law:

Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.

Ironically, the point Milton Friedman had originally made (pdf) in his critique of the use of the Phillips Curve for policy purposes–that such a use will change people’s expectations, and thus their behaviour, rendering the relationship between inflation and unemployment no longer useful for policy purposes–turned out to also apply to his own policy advice to target monetary aggregates being based, as it was, on the notion that monetary turnover (velocity) was relatively stable (or could be made so by quantitative targeting).

Victory (to a point)
Nevertheless, the wider macroeconomic victory of Milton Friedman–the acceptance that inflation is always and everywhere a monetary phenomenon–was a necessary step in the taming of inflation. Why? Because once the monetary nature of inflation was accepted, the responsibility of central banks for inflation became clear, incorporated in what is sometimes called the new neoclassical synthesis.  So the problem simply became a matter of finding a way to operationalise the responsibility of central banks. Such a way was found with inflation targeting. (Pioneered by, of all places, New Zealand under Reserve Bank of New Zealand Governor Don Brash.)

In other words, accepting that inflation was a monetary phenomenon gave the central banks no place to hide.

There were two problems which flowed from this. First, what became most widely accepted was narrow inflation targeting, where maintenance of price stability (typically defined as 2% inflation a year) became the only, or dominant, policy target of the central bank.

The second is that, in the wider economics profession, the dominant macroeconomics became New Keynesian economics, where the incorporation of monetarist notions is often glossed over: they do not play much part in David Romer’s 1993 paper (pdf), for example. The frequent use of Dynamic Stochastic General Equilibrium (DSGE) Models, which have some problems incorporating money and monetary effects, rather exacerbated this. Brad DeLong, conversely, makes explicit (pdf) the importance of what he calls Classic Monetarism in New Keynesianism.

Burdensome responsibility
Given the way central banks now pride themselves on–indeed, sometimes seem to define their role as–”taming” inflation, it is easy to forget how resistant many central banks were to the notion that inflation was their responsibility. And a major appeal of narrow inflation targeting is precisely that it minimises the responsibilities of central banks.

Which is why a new (market) monetarist victory is necessary. For the crucial step in flattening the business cycle is to gain acceptance that the intensity of the business cycle is also a monetary phenomenon: that central banks control the level of aggregate demand. Once that is accepted, the responsibility of central banks for stabilising the path of total spending on goods and services is clear, and it is just a matter of finding ways to operationalize that responsibility.

Given Scott Sumner’s very reasonable hypothesis that central banks (particularly the US Federal Reservetend to follow the macroeconomic consensus of the mainstream economics profession, this means the debate within said profession is very important; though still as part of the wider policy debate.

While central banks are not held accountable for the effects of what they do, and do not do, achieving a stable (macro)economic framework for people to go about the business of their lives is going to be a happy accident when it should be what policy makers—and specifically central bankers—are held accountable for.

ADDENDA: Noah Smith is very enthusiastic about Japanese PM Shinzo Abe because, among other reasons:

In other words, unlike everyone else in the world, Abe listened to Milton Friedman, and the results are looking good.

Hard money is not the same as sound money

By Lorenzo

A post by Jonathan Finegold on sound money pointed me towards how to express an important distinction–that hard money is not the same as sound money. JF defines sound money thusly:

a monetary system that best promotes coordination between market agents.

Unsurprisingly, a somewhat “Austrian” definition, but clear enough. I would go with the money that maximises its transaction utility, but it would come to much the same thing. Which is to say, money being sound is not merely about the exchange value of money (either for other monies or for goods and services), nor even its exchange value across time (i.e. its role as an asset), but also about the exchanges (transactions) it is used in. If money maintains or increases its exchange value against goods and services (measured by, say, the GDP deflator) but at the cost of depressing the level (measured by goods and services) of exchanges it is used in, then that is not sound money.

It is, however, hard money.

Which is the difference: hard money is money that maintains or increases its exchange value for goods and services (or other monies or both). The more it increases its said exchange value, the “harder” it is. But that does not tell us that how sound it is: indeed, often hardness and soundness are contra-indicated (more of one is less of the other). To increase money’s value as an asset is to reduce its moneyness and that way disaster (or, at least, much economic unpleasantness) lies, remembering that being an asset is the least distinctive thing about money.

Deflation distinction
The distinction between good, bad and ugly deflation is useful (pdf) here. Good deflation comes from falling prices due to increasing productivity. The IT industry is a classic example of good deflation–Moore’s law and all that. There is a sense in which the entire increase in living standards from whenever is all good deflation–if, for example, we use labour-time at average wages as our measure.

Bad and ugly deflation–what we might call monetary deflation–is all about money increasing in value relative to output, thereby depressing aggregate demand (i.e. total spending on goods and services), pushing downwards on income, raising the value of debt. Bad and ugly deflation is from hard money, from money increasing in exchange value. It is not sound money, as the actual use of money in productive transaction is trending downwards as money’s exchange value is trending up. Money-as-asset is overwhelming money-as-facilitator-of-transactions–the real point of money; what makes money, money.

Central banks should be sound, not hard
We do not want central banks to obsess over providing hard money, we want them to provide sound money. To focus on money as tool, not money as asset; to focus on its utility, its role in the economy as a whole, not on its (exchange) value. Narrow inflation targeting central banks–such as the Bank of Japan (BoJ) during the “lost decades“, the European Central Bank (ECB) since the Eurozone crisis–produce hard money. They do not produce sound money. The Reserve Bank of Australia (RBA) does that.

The most disastrous example of producing hard money which was desperately unsound was the policies of the Bank of France (BoF) in creating the Great Depression, the classic example of ugly deflation at its ugliest. Money was extremely hard (and getting harder and harder) but also catastrophically unsound. Money was “better and better” as an asset, worse and worse as a facilitator of transactions.

One problem is that hard money is actually relatively easy to produce and has a whole lot of ready-made chest-thumping rhetoric to go with it. It does not help that Austrian school theory has such a presumption towards central banks being inflationary, that the problem of hard money is simply not natural to their analytical framework. (Not a sin of all Austrian economists–several above links are to works by economists associated with the Austrian school–but one very common in the wider Austrian community.)

Disorder dangers
Another problem is the conservative penchant for producing fetishes of order–such as “preserving” the “value” (rather than the utility) of money. Hence so many conservatives riding the gold standard down to destruction in the Great Depression and so many obsessing over utterly imaginary inflationary dangers today. They focus on money as asset, losing sight of money as tool. On the thing itself and not its wider role, thereby actually failing to defend the wider system. They defend the fetish (the gold standard, narrow inflation targeting) as a bulwark of order, regardless of how much actual disorder it is creating.

Thereby, of course, undermining and discrediting the very social order they are so keen to defend.

Including the international order. Not only does the social disorder created by hard money make extremist regimes more likely, the economic contraction and stagnation hard money creates undermines the confidence and capacities of Western states. Folk have pointed to how much like a late 1930s Hitler Russian President Vladimir Putin is, except on behalf of Russians outside Rodina rather than Germans outside the Reich. That both were confronting Western Powers weakened in both strength and confidence by central bankers disastrously pursuing hard, rather than sound, money policies is another similarity less remarked upon.

Money qua money is a tool for transactions. Sacrificing its use (in transactions) for its (exchange) value is to undermine its real utility to an economy–which is to facilitate transactions, to have maximum transaction utility; to have a monetary system that best promotes coordination between market agents.

Hard money is really, really not the same as sound money.  It would be a massive step forward in public policy if more people understood that.


Too big not to fail: the rise and fall of Fannie Mae

By Lorenzo

The debate over the role (if any) of the Community Reinvestment Act (CRA) in the sub-prime crisis, and thus the Global Financial Crisis (GFC), often seems to be a stand-in for other issues. In particular, to what extent was either financial meltdown the consequences of government regulation (or the lack thereof).

The answer to the former question is: almost entirely, if by government regulation one includes the full gamut of government interventions and political game-playing. In a market economy, failures of regulation and government intervention always manifest as market outcomes. By the simple expedient of declaring such government interventions and regulations irrelevant or unimportant, said market outcomes can then be pointed to as “proof” of market failure.

But that is ideology blocking analysis. Corporations are pavlovian profit monsters–they will go where profits lead them. They act according to the incentives offered them, within the range of managerial competence. (Hence markets as economic selection processes.)

In the case of the US finance industry, particularly the US housing finance industry, various government interventions profoundly shaped the incentives facing participants in the market, with part of the problem being those being regulated having rather too much influence over how they were regulated.

With no entity playing the political game more relentlessly, narrowly effectively or ultimately self-destructedly than the Federal National Mortgage Association (FNMA) or Fannie Mae. As long-time Wall Street Journal journalist James R. Hagerty sets out in his highly readable history of Fannie Mae, The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall.

Supporting housing finance
Fannie Mae started operating in 1938, a late New Deal initiative. While fairly small in its early days, it grew until it became one of the biggest financial institutions in the world. For its first 30 years, it had a monopoly over the US secondary mortgage market. As an Australian reading the book, the idea that housing finance needed government support seems a little bizarre. We have a home-ownership rate slightly above the US’s (ex-communist countries generally top the rankings), but did not need to create anything like Fannie Mae or Freddie Mac, or the other US government founded/supported finance entities, to do it.

But such efforts suited some very politically effective interests, such as realtors. The implicit or explicit taxpayer guarantee allowed more funds to be pushed into housing at lower cost. At one point, Hagerty quotes Adam Smith‘s scepticism about government-sponsored companies:

These companies, though they may, perhaps, have been useful for the first introduction of some branches of commerce, by making at their own expense an experiment which the state might not think it prudent to make, have in the long run proved, universally, either burdensome or useless.

Fannie Mae provides a dramatic example of Adam having a point. The US$187bn the taxpayer’s invested in bailing out Fannie Mae and Freddie Mac may have been more than returned, but their role in fuelling destructive, massively over-leveraged, housing price booms imposed a much greater social cost than that.

Having previously read Fragile by Design, Hagerty’s book also put the CRA into a much more useful context, even though it plays a small role in his book. There was a long history of US federal government action to support housing finance. The CRA was a way of extending that pattern of action to urban minorities. The problem with the CRA was not the Act itself, but the way it then came to feed back into, and amplified, already existing patterns, which were also amplifying for other reasons. It was a building block in the edifice that created the sub-prime crisis, no more than that (but also no less).

Hagerty takes us through the history of Fannie Mae, with an enduring feature being attempts to either regulate it more closely, or to fully privatise it, being fought off by Fannie Mae. Fannie Mae wanted to keep its government guarantee (an implicit guarantee, once it became a company with shareholders), because that lowered the cost of its capital, but without tighter prudential regulation, because that would have reduced its ability to leverage off its government guarantee. Fannie Mae’s leadership played the political game increasingly effectively, including using such tactics as hiring as many lobbying firms as practicable, so they could not be hired to lobby against it.

To a large degree, Fannie Mae got the regulatory framework it wanted, though part of the trade-off became to expand its support for housing finance. As a result, the prudential rules covering it became increasingly vulnerable to catastrophic failure, if there was a large enough rise in interest rates or fall in house prices. Which, of course, there duly was.

Government guarantees to financial entities require matching prudential regulation if catastrophe is not to be avoided. But Fannie Mae was too politically useful; which it leveraged ruthlessly, to avoid inconvenient prudential regulation to match its government guarantee. Fannie Mae became too good at selling itself as the perfect (off-budget) housing finance problem solver.

As the various housing bubbles across the US started to deflate, a desperate housing industry lobbied hard for Congress to “do something”. And there was Fannie Mae and Freddie Mac, available to “do something” off-budget. So, as the housing bubbles deflated, Fannie Mae and Freddie Mac increased their exposure. But this was the end run of a long process of ever-lower standards of lending without compensating increases in prudential requirements.  The necessary corollary to government guarantees if said guarantees were not to make the financial system more vulnerable rather than less.

Pay and …
And then it all collapsed, wiping out Fannie Mae and Freddie Mac’s share values and requiring a $US187bn bailout of the two government-sponsored-enterprises (GSEs). It was as if nothing had been learnt from the Savings & Loans crisis. Which, in effect, it had not.

What Calomiris & Haber call the game of bank bargains has been perennially played in the US to suit narrow interests and not broad ones. As in this case, with the taxpayers left holding the bag (again) as helping the housing industry by “off-budget” measures suddenly went dramatically on-budget.

It is useless to complain that the politics was “corrupted”, as if that is the only problem: we have to deal with politics as it is, not as it might be. There is certainly a role for seeking to have better functioning institutions, for informed debate, for exposure. But to change nothing about the political institutions and framings of debate, and then expect the players to reliably and continually act differently, is naive at best.

It was not as if the housing booms themselves were not also significantly responses to regulation. Land rationing was a major driver of where the US housing booms did (or did not) occur. For any asset, if quantity responses are dampened, then price responses become more intense. That is, if supply is constrained (such as by land rationing), then the price of a class of assets (such as land-approved-for-housing) will become more susceptible to demand shocks (both upwards and downwards). Or, in this case, upwards then downwards. Especially if a government guarantee is leveraged into pumping more and cheaper finance into purchasing said asset.

So, local governments were rationing land (driving up house values and property tax revenue), Congress wanted off-budget help to the housing industry and home-owners (both middle class and those aspiring to be so), driving up the funds being pumped into supply-constrained markets, banks wanted to benefit from the too-big-to-fail subsidy, and prudential regulators either did not want to pick unfortunate fights or were overwhelmed by the superior lobbying power of those that they were attempting to regulate. With no-one playing the political game more effectively, or more ultimately disastrously, than Fannie Mae. Which became too politically big not to fail.

… then repeat
But Fannie Mae and Freddie Mac have been bailed out, not killed off. The too-big-to-fail subsidy is now absolutely established, as are the GSE‘s government guarantees. Blaming “Wall St” or “easy money”, or whatever, means that the game of helping a powerful industry off-budget–in part by not forcing sufficient prudential requirements to match the government guarantees–continues to be played. After all, the imbalance is very much based on providing (positive) externalities to those who usefully notice and passing the costs on to those who do not.

The Savings & Loans Crisis was Mark 1. The Sub-Prime Crisis was Mark 2. The pieces are being set in place to have Mark 3. With “corporate greed” the perennial theatrical villain, so that the real players can continue to play their political games, and taxpayers and home-owners can be set to take the fall, yet again.

But Hagerty’s book–clearly based on talking to everyone who matters and reading every report–provides a well-written, clear and informative history of past, present and (sadly) likely future.

The ECB’s dismal performance and the European elections

By Lorenzo

These two graphs, taken from here, express vividly how much worse the performance of the European Central Bank (ECB) has been compared to the US Federal Reserve (the Fed). Between the two of them, they caused the Great Recession, but the Fed has done much better since.

The ECB’s dismal performance also helps explain the recent European election results. Andrew Sullivan’s commentary on the EU election results is by far the most sensible thing on the results I have read, since he gets both sides and realises the underlying conflict has to be managed, not “won”. I particularly liked:

And, more to the point, Europeans increasingly feel they are not given a choice in any of this. So they vented.

Making folk feel ignored and powerless is not the path to social harmony. Also:

But when the money ran out, and the recession hit, and the EU only bailed out members on the basis of brutal austerity … the deal began to fray. Now that growth is returning, if only anemically, it appears, moreover, to be benefiting Blue Europe – the elites, the property-owners, the transnationals – while leaving ordinary, working- and middle-class Europeans in the dust. That fuels another layer of mistrust and despair.

The consequences of the ECB’s “hard money” policy continue to resonate, badly.

ADDENDA: Sociologist Frank Furedi also has very sensible things to say about the Eurosceptic vote and how not to think about it (via).

Small-yet-broad is beautiful (or why it is good to have been British)

By Lorenzo

The central purpose of Calomiris & Haber’s Fragile by Design: the Political Origins of Banking Crises is to explain to Americans why their banking system does not perform as well as other countries–particularly compared to that of their neighbour, Canada. In chapter 14, the authors put the matter quite starkly:

… if a highly stable banking system is defined as one that has been crisis-free since 1970, then only six out of 117 countries–Australia, Canada, Hong Kong, Malta, New Zealand, and Singapore–meet the threshold for being both credit abundant and crisis free.

As the authors note, all six were part of the British Empire. Three (Hong Kong, Malta and Singapore) are city-states. The other three (Australia, Canada and New Zealand) are among the world’s most stable and long-lived democracies. The authors argue that these latter three countries also have something else in common:

… the structures and political histories of these three countries tended to mitigate the ability of populists and bankers to form coalitions that disadvantage everyone else.

Something that is very clear, is that “de-regulation” is a term empty of explanatory power. All successful six have liberalised financial markets–Australia and New Zealand, for example, were leaders in financial “de-regulation”. If someone starts trying to blame the Global Financial Crisis (GFC) on “de-regulation”, you can stop reading, they have nothing useful to say.

It is very much the point of Calomiris & Haber’s Fragile by Design to look at these issues comparatively and historically, which gets in the way of all sorts of congenial ideological narratives. Their final chapter (Chapter 15) is entitled “Reality is a Plague on Many Houses” just to make that point–particularly that Americans need to look outside their own history for answers.

Playing the game
In Chapter 2, The Game of Bank Bargains, they make it quite explicit that the question is always the actual structure of financial regulation:

… the normal functioning of banks depends on three sets of property rights that only government can provide. Banks need powerful governments. But power may not be wielded in the interests of bankers unless bankers can convince the group in control of the government to partner with them.

Hence the game of bank bargains. Hence also the political origins of banking crises. Or, as they say:

… our goal is to explore why banking is all about politics–and always has been.

It is inherent in the nature of banking given that:

Any enterprise whose inputs and outputs consist primarily of promises to repay debts is inherently unstable and risky.

Banks have to deal with credit risk and liquidity risk. Hence banks are pioneers of limited liability laws:

… in the vast majority of countries, the first enterprises to seek charters granting their shareholders a limit on liability were banks: the special limited-liability acts for banks typically antedated general incorporation laws by decades.

Which brings the government into the heart of banking.

A bank cannot simply declare that its shareholders have limited liability or other legal protections. Only the government can offer these. It does so by granting privileges–through bank charters–and enforcing them in courts. A charter is not just a license; it is a contract between the bank and the government.

To have an effective bank bargain, (1) bank assets have to be protected from government expropriation, (2) minority shareholders and depositors have to be able to stop bank insiders expropriating their assets or else be compensated for accepting the risk of expropriation by bank insiders, and (3) there has to be mechanisms to protect bank insiders, minority shareholders and depositors from expropriation by borrowers or else be compensated for accepting the risk of expropriation by borrowers.

Since 1970, six jurisdictions have managed to do all that. Why so few jurisdictions? Because governments face conflicts of interest in managing the game of bank bargains. They regulate banks, but borrow from them. They discipline debtors, but often rely on them for political support. They allocates losses among creditors in cases of bank failures, but may simultaneously look to them for political support. The constant temptation is to shift the game of bank bargains to benefit those who usefully notice at the cost of those who do not; the arsonists in charge of the fire brigade problem, with government having, as Calomiris & Haber put it “multiple opportunities to behave opportunistically”.

Most governments fail this test. Hence only 6 out of 117 jurisdictions managing the game of bank bargains so as to provide abundant credit but avoiding bank crises.

If the standard is set so as to include countries that have avoided a crisis since 1970, but are only required to have a level of credit to GDP equal to the mean across all countries, we get all the way to 13 jurisdictions out of 117: the “successful six” are joined by the Bahamas, Bahrain, Barbados, Belize, Macao, Mauritius and South Africa. All are former parts of the British Empire, except Macao, and all achieved independence peacefully.

Out of the 13, all but 3 are small islands or city-states. While, like Australia and New Zealand, South Africa (since the 1997 constitution was a brokered deal with the white minority) has institutions which:

… make it hard to populist movements to form coalitions with banks to enact regulatory policies that benefit them at the expense of everyone else.

The US, by contrast, not so much.

Small islands and city-states dominate the list of the successful players of the game of bank bargains because they are simply much more likely to have broadly-based bargains. (Though Iceland is a salutary reminder that success is not guaranteed from being small.)

As for the worst performers, setting the criteria as having at least two bank crises since 1970 and credit to GDP ratio at or below average gives us: Chad, the Democratic Republic of Congo, Argentina, Bolivia, Brazil, Cameroon, the Central African Republic, Colombia, Costa Rica, Ecuador, Kenya, Mexico, Nigeria, the Philippines, Turkey and Uruguay. (Kenya is clearly letting the British-is-better side down, though its path to independence was marred by violence. [Nigeria is also letting the British-is-better side down, but it is really a mistake as a single country.]) Basically, as the authors point out, autocracies, new democracies or democracies whose institutions provide few barriers to rent-seeking.

Broadening the question

Flag_of_Barbados_(1870–1966)When we look at lists of per capita GDP on a purchasing price parity (PPP) basis, we can see that the US is the only large country in the top 10 persistently included: the others being small (less than 10 million in population) as well as oil-rich, monarchical or democratic (or some combination thereof–looking at you Norway). So, clearly the US continues to do something right.

Of course, since the US is seriously a federation, it could be argued it is really a bunch of small countries operating in close formation. That what is by far the largest state by population (California) is also something of a public-policy mess adds plausibility to the claim. As does the only two countries with populations of over 10 million to get into any of the lists being Canada and Australia (also federations).

Clearly, the trick is to have responsive states. With smaller being generally better, as information flows more easily and more inclusively. It is generally just harder to stick it to folks (either by what you do or what you don’t do) in a way that doesn’t get noticed in smaller jurisdictions. (Unless jurisdictions are so small they fly under the media radar but are big enough to be semi-anonymous–urban local government in Oz has a bit of a problem there.)

There is an important caveat though, which Calomiris & Haber identify in discussing why Canada’s “bank bargain” has consistently worked so much better than the US’s–forcing policy bargaining to be at a broad level is less likely to generate nasty externalities. The Canadian “game of bank bargains” was played at a national level in a parliamentary-and-imperial system, so created a stable, interests-encompassing bargain more sensitive to long-term consequences.

The US “game of bank bargains” was played at State and Federal levels in coalitions built by adding individual constituencies together in congressional systems, creating unstable, interests-excluding bargains less sensitive to long-term consequences. (Since banking is all about risks across time, long term consequences are a particular problem for bank bargains.) But that is not actually an argument for bigger-being-better (Canada was always a much less populous jurisdiction than the US). It is an argument for more broadly-based being better. And broader is easier if smaller.

Still, that politicians are going to be looking to craft useful (to them) externalities means we can only expect politicians to deal with awkwardly visible negative externalities, not be a general solution to the problem of externalities. And we should also be sceptical of public policy mechanisms well set up to generate politically useful externalities. My nominations:

Public ownership.
Bureaucratic approval systems. (Unconstitutional in Germany, and good on them–they get their reward in much more rational housing markets.)
Complex tax rules.
Low visibility regulations. (Which would be most of them.)

Arsonists in charge of the fire brigade

By Lorenzo

A favourite economic justification for state action is to deal with externalities–the effects on people of some action or transaction that they were not willingly a party to.  The problem with this is that the coercive nature of the state makes it a prime creator of externalities: since it has coercive power, it can force consequences on people they have not agreed to. While said coercive power makes the state, at least in theory, able to deal with externalities from private action, in practice, it makes the state a prime generator of externalities. Tyranny (taking the modern pejorative meaning, not the classical Greek technical meaning), the extreme version of forcing consequences on people they have not agreed to, is, after all, systematic negative externalities.

Democracy is supposed to make things better, by making all voters part of the political bargaining process. The problem with that is much of the art of representative politics is using the coercive power of the state to provide benefits to folk who do notice (and care and effectively politically express that noticing and caring) while shifting the costs onto those who do not. In other words, generating visible positive externalities paid for via not-usefully-noticed negative externalities. Politicians are entrepreneurs of externality. Appealing to politicians to deal with problems of externalities in general is rather like putting arsonists in charge of the fire brigade.

 Which is not to say there is no benefit to democracy: a whole lot of externalities that undemocratic regimes impose are usually avoided because visible negative externalities have a rather harder time getting through when all voters are part of the political bargaining process. Nobel Memorial Laureate Amartya Sen‘s point that democratic countries do not suffer from famines is well taken and part of a wider process. (As Calomiris & Haber point out in Fragile by Design, democracies are less susceptible to extreme versions of the inflation tax than weak autocracies, for example.)

Of course, if groups of voters are permanently locked out of the effective political process, then the advantages in political bargaining that democracy permits will be somewhat attenuated. If folk have a weak sense of there being a common public sphere in which bargaining takes places (and is supposed to be stuck to), including various categories of other folk as not acceptable bargaining partners, democracy will also have difficulties having getting social traction to operate against even obvious negative externalities.

The jihadi critique of democracy as blasphemous is precisely because changing the law to reflect social bargains is to infringe on Allah’s sovereignty, as the only legitimate law is Shariacreated by inference from the actions and words of Mohammad, God’s final Messenger and Guide. More generally, taking as an affront to treat non-believers the same as believers, or folk of x skin colour the same as folk of y skin colour, rather gets in the way of effective broad social bargaining via the democratic process.

The above thoughts on politicians in representative democracies and externalities were inspired by Calomiris & Haber’s discussion of the sub-prime crisis in Fragile by Design: the Political Origins of Banking Crises.

Imprudent community investment
Calomiris & Haber make it very clear that how the Community Reinvestment Act (CRA) came to operate was a central building block in the sub-prime crisis. Regulatory changes which (finally) allowed national branch banking in the US led to a wave of bank mergers, as firms tried to gain the too-big-to-fail subsidy–the implicit government guarantee which meant you could take higher risks with less capital coverage (i.e. seek more profits for any given level of capital backing). A classic example of what economists call moral hazard.

Mergers had to be approved, however, and so an alliance was forged between megabanks and community activists, notably ACORN. If megabanks undertook partnership arrangements with activist groups such as ACORN to have CRA programs run through said advocacy groups, then they would testify that the banks were “good citizens” and help get approval for the bank merger in question. If banks refused to play the game (or tried to have their own bank-run CRA programs), the activist groups would testify against the bank merger in question.

So, a winning political coalition was born. The banks got regulatory approval, the activist organisations got funding for their client base (and themselves) and politicians got credit support for low income constituents. All ultimately guaranteed by the taxpayer, but no-one consulted them. The megabuck-activist-urban politician coalition played the externality game very well. Positive externalities to people who noticed–and voted, donated, or advocated–and negative externalities to people who didn’t.

The Clinton and Bush II Administrations, as well as a majority in Congress, liked this game of taxpayer-sponsored cheap credit to worthy groups so much they kept upping the ante. Regulatory and other pressure was put on Fannie Mae and Freddie Macgovernment sponsored enterprises (GSEs), to “broaden” their credit provision–i.e. take on riskier and riskier low income would-be home-owners. With activist groups such as ACORN advocating and testifying in favour. The result–as having one set of standards for CRA recipients and another for other mortgagees would raise all sorts of awkward questions–was to massively shift upwards the level of risks of mortgages across the board. Which also helped protect Fannie Mae and Freddie Mac from regulatory challenge, since lots of middle class voters happily hopped on the (much) cheaper housing credit bandwagon and would not have appreciated having the cost of their home loans suddenly go up because regulators got antsie. (Thus, studies which compare CRA and non-CRA credit recipients miss the macro-point.)

As GSE’s, Fannie Mae and Freddie Mac also had (implicit) government guarantees. So, someone was paying for this upward risk spiral–the taxpayers providing the implicit or explicit guarantees. But they had not been told they were being dealt into this game.

This was all not good, but it was not enough to cause the eventual sub-prime meltdown. If prudential regulation had adjusted to force adequate capital coverage, then the final collapse would not have been anywhere near as bad. But that is precisely what the regulators did not do. They refused to pick a fight that would cause them nothing but grief–remember all those middle class voters hopping on the cheap housing credit bandwagon. Plus megabanks and activist groups all poised to testify that the nasty regulators were blocking the dream of homeownership to millions of low-income, minority Americans. And not merely poised–when various folk (Republicans representing rural electorates, concerned academics, Fed Chair Alan Greenspan) expressed concerns about the level of risk being taken on, groups such as ACORN testified and lobbied to make sure that the legislative changes from the reform push expanded the risk-taking.

It was, after all, all about helping poor Americans, particularly from minority groups, achieve the dream of home-ownership. Never mind the possible consequences, feel the noble intent.

Republican House Speaker Newt Gingrich was notably active in protecting the interests of the banking-and-housing coalition. Who were (particularly the GSEs) very good at recruiting key political staffers, putting projects in key Congressional districts, etc. As Calomiris & Haber point out, being cross-Party is part of being a successful policy coalition.

Then the house of cards collapsed and the taxpayers finally discovered what they had been dealt into. Though, because “Wall Street” and “easy monetary policy” copped the blame, the full understanding of how they had been fleeced does not seem to have sunk in. As Calomiris & Haber point out, the Dodd-Frank reforms don’t really address the key issues, because the megabank-activist-urban politician coalition still has the numbers in Congress. Indeed, the Obama Administration is still playing the same game. The housing-finance-subsidised-by-the-taxpayer-house-of-cards is being rebuilt as the “winning” coalition is still in place.

As Calomiris & Haber explain in detail, the US banking system has been perennially prone to banking crises because various winning political coalitions have ensured regulatory structures which make it so. All operating on the basis of positive externalities to people who notice (and count) and negative externalities to those who don’t. A long series of the arsonists being put in charge of the fire brigade.

Calomiris & Haber also point out that various countries have successfully avoided bank crises. But that is a matter for another post.

ADDENDA To clarify, and in response to a comment, the above is about the sub-prime crisis. The causes of the Great Recession are another matter.  (The sub-prime crisis no more caused the Great Recession than the Great Crash caused the Great Depression: both global economic downturns were the result of disastrous monetary policies by central banks.)