Tag Archives: rent seeking

A Fiscal Real-Bills Doctrine? No Such Thing As Painless Inflation Tax

14 Tuesday Jun 2022

Posted by in Fiscal policy, Inflation, Uncategorized

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A remarkable proposal made recently by Representative Ro Khanna (D -CA) would have the Biden Administration impose price controls, which would be bad enough. Khanna also would like the federal government to cover the inflation losses incurred by Americans by having it directly purchase certain goods and services and resell them “cheap” to consumers. In fairness, Khanna says the government should attempt to take advantage of dips in prices for oil, food commodities, and perhaps other necessities, which of course would limit or reverse downward price changes. When asked about Khanna’s proposal, Pete Buttigieg, Joe Biden’s Transportation Secretary, replied that there were great ideas coming out of Congress and the Administration should consider them. Anyway, the idea is so bad that it deserves a more thorough examination.

Central Planners Have No Clothes

First, such a program would represent a massive expansion in the scope of government. It would also present ample opportunities for graft and cronyism, as federal dollars filter through the administrative layers necessary to manage the purchases and distribution of goods. Furthermore, price and quantity would then be shaded by a heavy political component, often taking precedence over real demand and cost considerations. And that’s beyond the crippling “knowledge problem” that plagues all efforts at central planning.

One of the most destructive aspects of allowing government to absorb a greater share of total spending is that government is not invested with the same budgetary discipline as private buyers. Take no comfort in the notion that the government might prove expert at timing these purchases to leverage price dips. Remember that government always spends “other people’s money”, whether it comes from tax proceeds, lenders, or the printing press (and hence future consumers, who have absolutely no agency in the matter). Hence, price incentives take on less urgency, while political incentives gain prominence. The loss of price sensitivity means that government expenditures are likely to inflate more readily than private expenditures. This is all the more critical at a time when inflation is becoming embedded in expectations and pricing decisions. Khanna thus proposes an inflation “solution” that puts less price-sensitive bureaucrats in charge of actual purchases. That’s a prescription for failure.

If anyone in Biden’s White House is seriously considering a program of this kind, and let’s hope they’re not, they should at least be aware that direct subsidies for the purchase of key goods would be far more efficient. It’s also possible to hedge the risk of future price increases on commodities markets, perhaps simply distributing hedging gains to consumers when they pay off. However, having the federal government participate as a major player in commodities options and futures is probably not on the table at this point … and I shudder to think of it, but it might be more efficient than Khanna’s vision.

A Fiscal Real Bills Doctrine

Khanna’s program would almost surely cause inflation to accelerate. Inflation itself a form of taxation imposed by profligate governments, though it’s an inefficient tax since it creates greater uncertainty. Higher prices deflate the real value of most government debt (borrowed from the public), assets fixed in nominal value, and incomes. Read on, but this program would have the government pay your inflation tax for you by inflating some more. Does this sound like a vicious circle?

Khanna’s concept of inflation-relief is a fiscal reimagining of a long-discredited monetary theory called the “Real Bills Doctrine”. According to this doctrine, rising prices and costs necessitate additional money creation so that businesses have the liquidity to pay the bills associated with ongoing productive efforts. The “real” part is a reference to the link between business expenses and actual production, despite the fact that those bills are expressed in nominal terms. The result of this policy is a cycle of ever-higher inflation, as ever-more money is printed. This was the policy utilized by the Reichsbank in Weimar Germany during its hyperinflation of 1922-23. It’s really quite astonishing that anyone ever thought such a policy was helpful!

In Khanna’s version of the doctrine, the government spends to relieve cost pressure faced by consumers, so the rationale has nothing to do with productive effort.

Financing and the Central Bank Response

It’s reasonable to ask how these outlays would be financed. In all likelihood, the U.S. Treasury would borrow the funds at interest rates now at 10-15 year highs, which have risen in part to compensate investors for higher inflation.

My bet is that Khanna imagines the Fed would simply “print” money (i.e., buy the new government debt floated by the Treasury to pay for the program). This is the prescription of so-called Modern Monetary Theory, whose adherents have either forgotten or have never learned that money growth and inflation is a costly and regressive form of taxation.

Most economists would say the response of the Federal Reserve to this fiscal stimulus would bear on whether it really ignites additional inflationary pressure. Of course, rather than borrowing, Congress could always vote to levy higher taxes on the public in order to pay the public’s inflation tax burden! But then what’s the point? Well, taxing at least has the virtue of not fueling still higher inflation, and the Fed would not have a role to play.

But if the government simply borrows instead, it adds to the already bloated supply of government debt held by the public. This borrowing is likely to put more upward pressure on interest rates, and the federal government’s mounting interest expense requires more financing. What then might the Fed do?

The Fed is an independent, quasi-government entity, so it would not have to accommodate the additional spending by printing money (buying the new Treasury debt). Either way, investors are increasingly skeptical that the growing debt burden will ever be reversed via future surpluses. The fiscal theory of the price level holds that something must reduce the real value of government debt (in order to satisfy the long-term fiscal budget constraint). That “something” is a higher price level. This position is not universally accepted, and some would contend that if the Fed simply set a nominal GDP growth target and stuck to it, accelerating inflation would not have to follow from Khanna’s policy. The same if the Fed could stick to a symmetric average inflation target, but they certainly haven’t been up to that task. Hoping the Fed would fully assert its independence in a fiscal hurricane is probably wishful thinking.

Conclusion

There are no choke points in the supply chain for bad ideas on the left wing of the Democratic Party, and they are dominating party centrists in terms of messaging. The answer, it seems, is always more government. High inflation is very costly, but the best policy is to rein it in, and that requires budgetary and monetary discipline. Attempts to make high inflation “painless” are misguided in the first instance because they short-circuit consumer price responses and substitution, which help restrain prices. Second, the presumption that an inflation tax can be “painless” is an invitation to fiscal debauchery. Third, expansive government brings out hoards of rent seekers instigating corruption and waste. Finally, mounting public debt is unlikely to be offset by future surpluses, and that is the ultimate admission of Modern Monetary Theory. A fiscal real bills doctrine would be an additional expression of this lunacy. To suggest otherwise is either sheer stupidity or an exercise in gaslighting. You can’t inflate away the pain of an inflation tax.

ESG Scoring: Political Tool Disguised as Investment Guide

30 Wednesday Mar 2022

Posted by in Capital Markets, Corporatism, Environmental Fascism, Social Justice

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ESG scores are used to rate companies on “Environmental, Social, and Governance” criteria. The truth, however, is that ESGs are wholly subjective measures of company performance. There are many different ESG scores available, with no uniform standards for methodology, specific inputs, or weighting schemes. If you think quarterly earnings reports are manipulated, ESGs are an even more pliable tool for misleading investors. It is a market fad, and fund managers are using it as an excuse to charge higher fees to investors. But like any trending phenomenon, for a time, the focus on ESGs might feed-back positively to returns on favored companies. That won’t be sustainable, however, without legislative and regulatory cover, plus a little manipulative help from the ESG engineers and “Great Reset” propagandists.

It’s 100% Political, 0% Economic

ESGs are founded on prioritizing objectives that have little to do with shareholder value or any well-understood yardsticks of financial or operating performance. The demands on company resources for scoring highly on ESG are often nakedly political. This includes adoption of environmental goals such as fraudulent “zero carbon” impacts, the nebulous “sustainability” objective promoted by “green” activists, diversity, inclusion and equity initiatives, and support for activist groups such as Black Lives Matter and Antifa.

Concepts like “stakeholder value” are critical to the rationale for ESGs. “Stakeholders” can include employees, suppliers, and customers, as well as potential employees. suppliers, and customers. In other words, they can be just about anyone in the broader community, or more likely activists for “social change” whose interests have but the thinnest connection to the business’s productive activities. In essence, so-called stakeholder capitalism amounts to a ceding of control over corporate resources, and ultimately confiscation of wealth from equity owners.

Corporations have long engaged in various kinds of defensive actions, amounting to a modern-day trade in indulgences. No one will be upset about your gas-powered fleet if you buy enough carbon offsets, which just might neutralize the impact of the fleet on your ESG! On a more sinister level, ESG’s provide opportunities for cover against information that might be damaging to firms, such as the use of slave labor overseas. Flatter the right people, give to their causes, “partner” with them on pet initiatives, and your sins will be ignored and your ESG will climb! And ESGs are used in attempts to pacify leftist investors who see the corporation as a vessel for their own social objectives, quite apart from any mission it might have had as a productive enterprise.

Your ESG will shine if you do business that’s politically-favored, like renewable energy, despite its inefficiencies and significant environmental blemishes. But ESGs are not merely used to reward those anointed as virtuous by the Left. They are more forcefully used to punish firms in industries that are out of favor, or firms refusing to participate in buying off authoritarian crusaders. For example, you might be so berserk as to think fossil fuels and climate change represent imminent threats of catastrophe. Naturally, you’ll want to punish oil and gas producers. In fact, if you are in charge of ESG modeling, you might want to penalize almost any extraction industry, with certain exceptions: the massive extraction and disposal costs of renewables will pass without notice.

All these machinations occur despite the huge uncertainty surrounding flimsy, model-based predictions of warming and global catastrophe. Never mind that fossil fuels are still relied upon to provide for most of our energy needs and will be for some time to come, including base-load power generation when intermittency prevents renewables from meeting demand. The stability of the power grid depends upon the availability of carbon-based energy, which in fact is marvelously efficient. Yet the ESG crowd (not to mention the Biden Administration) seeks to drive up its cost, including the cost of capital, and these added costs fall most heavily on the poor.

ESG-guided efforts by activists to deny capital to certain segments of the energy sector may constitute antitrust violations. Some big players in the financial industry, who together manage trillions of dollars in investment funds, belong to an advocacy organization called Climate Action 100+. They coordinate on a mission to completely transform the energy industry via “green” investments and divestments of presumptively “dirty” concerns. These players and their clients have huge investments in green energy, and it is in their interest to provide cheap capital to those firms while denying capital to fossil fuel industries. As Arizona Attorney General Mark Brnovich writes at the link above, this is restraint of trade “hiding in plain sight”.

Manipulation

ESGs could be the mother of all principal-agent problems. Corporate CEOs, hired by ownership as stewards and managers of productive assets, are promoting these metrics and activities, which may not align with the interests of ownership. ESG’s are not standardized, and most users will have little insight into exactly how these “stakeholder” sausages are stuffed. In fact, much of the information used for ESGs is extremely ad hoc, not universally disclosed, and is often qualitative. The applicability of these scores to the universe of stocks, and their reliability in guiding investment decisions, is extremely questionable no matter what the investor’s objectives. And of course the models can be manipulated to produce scores that suit the preferences of money managers who have a stake in certain firms or industry segments, and who inflate their fees in exchange for ESG investment advice. And firms can certainly engage in deceptions that boost ESGs, as already discussed.

Like many cultural or consumer trends, investment trends can feed off themselves for a time. If there are enough “woke” investors, ESGs might well feed an unvirtuous cycle of stock purchases in which returns become positively correlated with wokeness. Such a divorce from business fundamentals will eventually take its toll on returns, especially when economic or other conditions present challenges, but that’s not the answer you’ll get from many stock pickers and investment pundits.

At the same time, there are ways in which the preoccupation with ESGs dovetails with the rents often sought in the political arena. Subsidies, for example, will be awarded to firms producing renewables. Politically favored firms are also likely to receive better regulatory treatment.

There are other ways in which firms engaging in wasteful activities can survive profitably, at least for a time. Monopoly power is one, and companies often develop a symbiosis with regulators that hampers smaller competitors. This is traditional rent-seeking corporatism in action, along with the “too-big-to-fail” regime. Sometimes sheer growth in demand for new technologies or networking potential helps to conceal waste. Hot opportunities can leave growing companies awash in cash, some of which will be burned in wasteful endeavors. ESG scoring offers them additional cover.

Cracks In the Edifice

John Cochrane notes a fundamental, long-term contradiction for those who invest based on ESGs: an influx of capital will tend to drive down returns in those firms and industries, while the returns on firms having low ESGs will be driven upward. Yet advocates claim you can invest for virtue and superior returns. That can’t outlast real market forces, especially as ESG efforts dilute any mission a firm might have as a productive enterprise.

Vladimir Putin’s brutal invasion of Ukraine has revealed other cracks in the ESG edifice. We now have parties arguing that defense stocks should be awarded ESG points! Also, that oil production by specific nations should be scored highly. There is also an awakening to the viability of nuclear power as an energy source. Then we have the problem of delivering on Biden’s promise to Europe of more liquified natural gas exports. That will be difficult given the way Biden has bludgeoned the industry, as well as the ESG conspiracy to deny it access to capital. Just watch the ESG hacks backpedal. Now, even the evangelists at Blackrock are wavering. To see the thread of supposed ESG consistency unravel would be enough to make you laugh if the entire conspiracy weren’t so grotesque.

Closing

The pretensions underlying “green” initiatives undertaken by large corporations are good mainly for virtue signaling, to collect public subsidies, and to earn better ESG scores. They are usually wasteful in a pure economic sense. The same is true of social justice and diversity initiatives, which can be perversely racist in their effects and undermine the rule of law.

Ultimately, we must recognize that the best contribution any producer can make to society is to create value for shareholders and customers by doing what it does well. The business world, however, has gone far astray in the direction of rank corporatism, and keep this in mind: any company supporting a sprawling HR department, pervasive diversity efforts, “sustainability” initiatives, and preoccupations with “stakeholder” outreach is distracted from its raison d’etre, its purpose as a business enterprise to produce something of value. It is probably captive to outside interests who have essentially commandeered management’s attention and shareholders’ resources.

When it comes to investing, I prefer absolute neutrality with respect to out-of-mission social goals. Sure, do no harm, but the focus should remain squarely on goals inherent in the creation of value for customers and shareholders.

Homeownership, Pensions, and the Wealth Distribution

13 Monday Dec 2021

Posted by in Markets, Wealth Distribution

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My theme in “What’s To Like About Income Inequality?” was the existence of natural drivers of an unequal distribution of income, as where institutions reward merit and legal systems assign strong property rights. I also discussed trends in income and wealth inequality and how standard measures of inequality are distorted by income taxes and transfer payments, including differences in unrealized and realized capital gains. Furthermore, income mobility makes “snapshots” of inequality less compelling, as individuals are not “stuck” for all time at a point in the income distribution, but are typically moving across the distribution and usually upward as they age through their working years.

Wealth inequality is another matter, but a new paper by Daniel Waldenström entitled “Wealth and History: An Update” shows that wealth concentration, which he defines as the share of wealth held by the top 1%, declined markedly between 1920 and 1970 in Europe and the U.S. After 1970, however, the share remained flat in Europe and was flat in the U.S. as well if unfunded pensions and Social Security benefits are valued as wealth. However, the near-entirety of the earlier decline in U.S. wealth concentration occurred by about 1950.

So a great thinning in the fat right tail of the wealth distribution occurred during the middle years of the 20th century. Waldenström attributes this transition to growth of homeownership and pension assets. These are so-called “popular assets” because they are held more broadly than the legacy wealth of the 1800s and early twentieth century:

“… the structure of private wealth has changed over the twentieth century, from being dominated by elite fortunes in agriculture or businesses to consisting mainly of widely dispersed assets in housing and funded pensions.”

Waldenström concludes that the facts run contrary to claims that wealth inequality has worsened in Western, capitalist economies over the years:

“These new findings have implications for the historiography of Western wealth accumulation and wealth concentration. They cast doubt over the view that an unfettered capitalism, such as in pre-democratic and pre-taxation nineteenth-century Europe, generates extreme levels of capital accumulation. The new findings also question the pivotal role of wars, crises and progressive taxation as the sole important factors behind the wealth equalization of the twentieth century.

Waldenström considers the role of progressive taxation in equalizing wealth, but he acknowledges that taxes undermined wealth accumulation at all levels, so the effect was ambiguous. A point on which I’d take issue with Waldenström is the role of regulation, which he believes “curbed the growth of large fortunes”. That might be true in some cases, but this effect is also subject to ambiguity. Regulation is often welcomed by powerful market players as a way of consolidating market position and hindering new competition. The regulatory state has long been considered a primary channel for rent seeking, so the impact on the wealth distribution is likely to be mixed.

Market institutions, together with rising education levels, labor reforms, and gains in productivity enabled this broadening in the accumulation and distribution of wealth. Social Security certainly played a part as well, though we don’t know how private pensions might have evolved in its absence. Of course, Social Security has a terrible record as an “investment” of payroll taxes. Private control over the investment direction of those funds would have done far better, and still could, which would be a further boon to wealth for the lower 99%.

It is true that inequality in both income and wealth is to be expected under merit-based systems of rewards. However, Daniel Waldenström’s paper offers evidence that markets do not merely concentrate wealth at the expense of workers. Rather, they deliver gains to all participants, who are in turn free to accumulate wealth in the kinds of “popular assets” discussed by Waldenström.

Climate Alarmism and Junk Science

02 Thursday Dec 2021

Posted by in Climate, Research Bias, Uncategorized

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The weak methodology and accuracy of climate models is the subject of an entertaining Norman Rogers post. I want to share just a few passages along with a couple of qualifiers.

Rogers quotes Kevin Trenberth, former Head of Climate Analysis at the National Center for Atmospheric Research, with apparent approval. Oddly, Rogers does not explain that Trenberth is a strong proponent of the carbon-forcing models used by the UN’s Intergovernmental Panel on Climate Change (IPCC). He should have made that clear, but Trenberth actually did say the following:

“‘[None of the] models correspond even remotely to the current observed climate [of the Earth].’“

I’ll explain the context of this comment below, but it constitutes a telling admission of the poor foundations on which climate alarmism rests. The various models used by the IPCCc are all a little different and they are calibrated differently. I’ve noted elsewhere that their projections are consistently biased toward severe over-predictions of temperature trends. Rogers goes on from there:

“The models can’t properly model the Earth’s climate, but we are supposed to believe that, if carbon dioxide has a certain effect on the imaginary Earths of the many models it will have the same effect on the real earth.”

But how on earth can a modeler accept the poor track record of these models? It’s not as if the bias is difficult to detect! On this question, Rogers says:

“The climate models are an exemplary representation of confirmation bias, the psychological tendency to suspend one’s critical facilities in favor of welcoming what one expects or desires. Climate scientists can manipulate numerous adjustable parameters in the models that can be changed to tune a model to give a ‘good’ result.“

And why are calamitous projections desirable from the perspective of climate modelers? Follow the money and the status rewards of reinforcing the groupthink:

“Once money and status started flowing into climate science because of the disaster its denizens were predicting, there was no going back. Imagine that a climate scientist discovers gigantic flaws in the models and the associated science. Do not imagine that his discovery would be treated respectfully and evaluated on its merits. That would open the door to reversing everything that has been so wonderful for climate scientists. Who would continue to throw billions of dollars a year at climate scientists if there were no disasters to be prevented? “

Indeed, it has been a gravy train. Today, it is reinforced by green-preening politicians, the many billions of dollars committed by investors seeking a continuing flow of public subsidies for renewables, tempting opportunities for international redistribution (and graft), and a mainstream media addicted to peddling scare stories. The parties involved all rely on, and profit by, alarmist research findings.

Rogers’ use of the Trenberth quote above might suggest that Trenberth is a critic of the climate models used by the IPCC. However, the statement was in-line with Trenberth’s long-standing insistence that the IPCC models are exclusively for constructing “what-if” scenarios, not actual forecasting. Perhaps his meaning also reflected his admission that climate models are “low resolution” relative to weather forecasting models. Or maybe he was referencing longer-term outcomes that are scenario-dependent. Nevertheless, the quote is revealing to the extent that one would hope these models are well-calibrated to initial conditions. That is seldom the case, however.

As a modeler, I must comment on a point made by Rogers about the use of ensembles of models. That essentially means averaging the predictions of multiple models that differ in structure. Rogers denigrates the approach, and while it is agnostic with respect to theories of the underlying process generating the data, it certainly has its uses in forecasting. Averaging the predictions of two different models with statistically independent and unbiased predictions will generally produce more accurate forecasts than the individual models. Rogers may or may not be aware of this, but he has my sympathies in this case because the IPCC is averaging across a large number of models that are clearly biased in the same direction! Rogers adds this interesting tidbit on the IPCC’s use of model ensembles:

“There is a political reason for using ensembles. In order to receive the benefits flowing from predicting a climate catastrophe, climate science must present a unified front. Dissenters have to be canceled and suppressed. If the IPCC were to select the best model, dozens of other modeling groups would be left out. They would, no doubt, form a dissenting group questioning the authority of those that gave the crown to one particular model.”

Rogers discusses one more aspect of the underpinnings of climate models, one that I’ve covered several times on this blog. That is the extent to which historical climate data is either completely lacking, plagued by discontinuities or coverage, or distorted by imperfections in measurement. The data used to calibrate climate models has been manipulated, adjusted, infilled, and estimated over lengthy periods by various parties to produce “official” and unofficial temperature series. While these efforts might seem valiant as exercises in understanding the past, they are fraught with uncertainty. Rogers provides a link to the realclimatescience blog, which details many of the data shortcomings as well as shenanigans perpetrated by researchers and agencies who have massaged, imputed, or outright created these historical data sets out of whole cloth. Rogers aptly notes:

“The purported climate catastrophe ahead is 100% junk science. If the unlikely climate catastrophe actually happens, it will be coincidental that it was predicted by climate scientists. Most of the supporting evidence is fabricated.”

Hyperbolic Scenarios, Crude Climate Models, and Scientism

07 Sunday Nov 2021

Posted by in Climate science, Global Warming

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What we hear regarding the dangers of climate change is based on predictions of future atmospheric carbon concentrations and corresponding predictions of global temperatures. Those predictions are not “data” in the normal, positive sense. They do not represent “the way things are” or “the way things have been”, though one might hope the initial model conditions align with reality. Nor can the predictions be relied upon as “the way things will be”. Climate scientists normally report a range of outcomes produced by models, yet we usually hear only one type of consequence for humanity: catastrophe!

Models Are Not Reality

The kinds of climate models quoted by activists and by the UN’s Intergovernmental Panel on Climate Change (IPCC) have been around for decades. Known as “carbon forcing” models, they are highly simplified representations of the process determining global temperatures. The primary forecast inputs are atmospheric carbon concentrations over time, which again are themselves predictions.

It’s usually asserted that climate model outputs should guide policy, but we must ask: how much confidence can we have in the predictions to allow government to take coercive actions having immediate, negative impacts on human well being? What evidence can be marshaled to show prospective outcomes under proposed policies? And how well do these models fit the actual, historical data? That is, how well do model predictions track our historical experience, given the historical paths of inputs like carbon concentrations?

Faulty Inputs

The IPCC has been defining and updating sets of carbon scenarios since 1990. The scenarios outline the future paths of greenhouse gas emissions (and carbon forcings). They were originally based on economic and demographic modeling before an apparent “decision by committee” to maintain consistency with scenarios issued in the past. Roger Pielke Jr. and Justin Ritchie describe the evolution of this decision process, and they call for change:

“Our research (and that of several colleagues) indicates that the scenarios of greenhouse gas (GHG) emissions through the end of the twenty-first century are grounded in outdated portrayals of the recent past. Because climate models depend on these scenarios to project the future behavior of the climate, the outdated scenarios provide a misleading basis both for developing a scientific evidence base and for informing climate policy discussions. The continuing misuse of scenarios in climate research has become pervasive and consequential—so much so that we view it as one of the most significant failures of scientific integrity in the twenty-first century thus far. We need a course correction.”

One would certainly expect the predicted growth of atmospheric carbon to evolve over time. However, as Pielke and Ritchie note, the IPCC’s baseline carbon scenario today, known as RCP8.5 (“Representative Concentration Pathway”), is remarkably similar to the “business as usual” (BAU) scenario it first issued in 1990:

“The emissions scenarios the climate community is now using as baselines for climate models depend on portrayals of the present that are no longer true. And once the scenarios lost touch with reality, so did the climate, impact, and economic models that depend on them for their projections of the future. Yet these projections are a central part of the scientific basis upon which climate policymakers are now developing, debating, and adopting policies.”

The authors go on to discuss a few characteristics of the BAU scenario that today seem implausible, including:

“… RCP8.5 foresees carbon dioxide emissions growing rapidly to at least the year 2300 when Earth reaches more than 2,000 ppm of atmospheric carbon dioxide concentrations. But again, according to the IEA and other groups, fossil energy emissions have likely plateaued, and it is plausible to achieve net-zero emissions before the end of the century, if not much sooner.”

Pielke and Ritchie demonstrate that the IPCC’s baseline range of carbon emissions by 2045 is centered well above (actually double) the mid-range of scenarios developed by the International Energy Agency (IEA), and there is very little overlap between the two. However, global carbon emissions have been flat over the past decade. Even if we extrapolate the growth in atmospheric CO2 parts per million over the past 20 years, it would rise to less than 600 ppm by 2100, not 1,200 ppm. It’s true that a few countries (China comes to mind) continue to exploit less “carbon efficient” energy resources like coal, but the growth trend in concentrations is likely to continue to taper over time.

It therefore appears that the IPCC’s climate scenarios, which are used broadly as model inputs by the climate research community, are suspect. As one might suspect: garbage in, garbage out. But what about the climate models themselves?

Faulty Models

The model temperature predictions have been grossly in error. They have been and continue to be “too hot”. The chart at the top of this post is typical of the comparisons of model projections and actual temperatures. Before the year 2000, most of the temperature paths projected by the particular model charted above ran higher than actual temperatures. However, the trends subsequently diverged and the gap has become more extreme over the past two decades.

The problem is not merely one of faulty inputs. The models themselves are deeply flawed, as they fail to account adequately for natural forces that strongly influence our climate. It’s been clear for many years that the sun’s radiative energy has a massive impact on temperatures, and it is affected not only by the intensity of the solar cycle but also by cloud cover on Earth. Unfortunately, carbon forcing models do not agree on the role that increased clouds might have in amplifying warming. However, a reduction in cloud cover over the past 20 years, and a corresponding increase in radiative heat, can account for every bit of the warming experienced over that time.

This finding not only offers an alternative explanation for two decades of modest warming, it also strikes at the very heart of the presumed feedback mechanism usually assumed to amplify carbon-induced warming. The overall effect is summarized by the so-called carbon sensitivity, measured as the response of global temperature to a doubling of carbon concentration. The IPCC puts that sensitivity in a range of 1.5C to 4.5C. However, findings published by Nic Lewis and Judith Curry are close to the low end of that range, as are those found by Frank Bosse reported here. The uncertainties surrounding the role of cloud cover and carbon sensitivities reveal that the outputs relied upon by climate alarmists are extreme model simulations, not the kind of reliable intelligence upon which drastic policy measures should be taken.

The constant anxiety issued from the Left on the issue of climate change, and not a little haranguing of the rest of us, is misplaced. The IPCC’s scenarios for the future paths of carbon concentration are outdated and seriously exaggerated, and they represent a breach of scientific protocol. Yet the scenarios are widely used as the basis of policy discussions at both the domestic and international levels. The climate models themselves embed questionable assumptions that create a bias toward calamitous outcomes.

Yet Drastic Action Is Urged

The UN’s 2021 climate conference, or COP26 (“Conference of the Parties …”) is taking place in Glasgow, Scotland this month. Like earlier international climate conferences, the hope is that dire forecasts will prompt broad agreement on goals and commitments, and that signatory countries will translate these into policy at the national level.

Things got off to a bad start when, before COP26 even began, the G20 nations failed to agree on a goal of “net-zero” carbon emissions by 2050. Another bad portent for the conference is that China and India, both big carbon emitters, will not attend, which must be tremendously disappointing to attendees. After all, COP26 has been billed by Prince Charles himself as “the last chance saloon, literally”, for saving the world from catastrophe. He said roughly the same thing before the Paris conference in 2014. And Joe Brandon … er, Biden, blurted some hyperbole of his own:

“Climate change is already ravaging the world. … It’s destroying people’s lives and livelihoods and doing it every single day. … It’s costing our nations trillions of dollars.”

All this is unadulterated hogwash. But it is the stuff upon which a crisis-hungry media feeds. This hucksterism is but one form of climate rent-seeking. Other forms are much more troubling: scary scenarios and model predictions serve the self-interest of regulators, grant-seeking researchers, interventionist politicians, and green investors who suckle at the public teat. It is a nightmare of scientism fed by the arrogance of self-interested social planners. The renewable energy technologies promoted by these investors, politicians, and planners are costly and land-intensive, providing only intermittent output (requiring backup fossil fuel capacity), and they have nasty environmental consequences of their own.

The precautionary principle is no excuse for the extreme policies advocated by alarmists. We already have economically viable “carbon efficient” and even zero-carbon energy alternatives, such as natural gas, modular nuclear power, and expanded opportunities for exploiting geothermal energy. This argues against premature deployment of wasteful renewables. The real crisis is the threat posed by the imposition of draconian green policies to our long-term prosperity, and especially to the world’s poor.

Defang the Administrative State

14 Wednesday Apr 2021

Posted by in Administrative State, Discrimination, Free Speech

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The American administrative state (AS) was borne out of frustration by statist reformers with expanded voting rights. It continues to be an effective force of exclusion and discrimination today, according to Philip Hamburger of Columbia Law School. I’ve discussed Hamburger’s commentary in the past on the extra-legal power often wielded by administrative agencies, and I will quote him liberally in what follows. At the first link above, he provides some historical context on the origins of the AS and discusses the inherently discriminatory nature of administrative law and jurisprudence.

An Abrogation of Voting Rights

Hamburger quotes Woodrow Wilson from 1887 on the difficulty of appealing to a broad electorate, a view that was nothing short of elitist and bigoted:

“‘… the reformer is bewildered’ by the need to persuade ‘a voting majority of several million heads.’ He worried about the diversity of the nation, which meant that the reformer needed to influence ‘the mind, not of Americans of the older stocks only, but also of Irishmen, of Germans, of Negroes.’ Put another way, ‘the bulk of mankind is rigidly unphilosophical, and nowadays the bulk of mankind votes.’”

Wow! Far better, thought Wilson, to leave the administration of public policy to a class of educated technocrats and thinkers whose actions would be largely independent of the voting public. But Wilson spoke out of both sides of his mouth: On one hand, he said that administration “lies outside the proper sphere of politics“, but he also insisted in the same publication (“The Study of Administration“) that public administration “must be at all points sensitive to public opinion“! Unfortunately, the views of largely independent public administrators seldom align with the views of the broader public.

Administration and Prejudice

Wilson was elected President 25 years later, and his administration did much to expand the administrative powers of the federal executive. Over the years, the scope of these powers would expand to include far more than mere administrative duties. Administrative rule-making would come to form a deep body of administrative law. And while traditional legislation would nominally serve to “enable” this activity, it has expanded in ways that are not straightforwardly connected to statute, and its impact on the lives of ordinary Americans has been massive. Furthermore, a separate legal system exists for adjudicating disputes between the public and administrative agencies, with entirely separate rules and guarantees than our traditional legal system:

“It is bad enough that administrative proceedings deny defendants many of the Constitution’s guaranteed civil procedures. … In addition, all administrative proceedings that penalize or correct are criminal in nature, and they deny defendants their procedural rights, such as their right to a jury and their right to be presumed innocent until proven guilty beyond a reasonable doubt. Of course, these administrative proceedings deny procedural rights to all Americans, but they are especially burdensome on some, such as the poor.“

The AS has truly become a fourth, and in many ways dominant, branch of government. Checks and balances on its actions are woefully inadequate, and indeed, Wilson considered that a feature! It represents a usurpation of voting rights, but one that is routinely overlooked by defenders of universal suffrage. It is also highly prejudiced and discriminatory in its impact, which is routinely overlooked by those purporting to fight discrimination.

Bio-Medical Discrimination

Hamburger devotes some of his discussion to Institutional Review Boards (IRBs), which are mandated by federal law to conduct prior reviews of research in various disciplines. These boards are generally under the authority of the Department of Health and Human Services. One major objective of IRBs is to prevent research involving human subjects, but this prohibition can be very misguided, and the reviews impose costly burdens and delays of studies, often stopping them altogether on trivial grounds:

“This prior review inevitably delays and prevents a vast array of much entirely innocent bio-medical research. And because the review candidly focuses on speech in both the research and its publication, it also delays and prevents much bio-medical publication.

The consequences, particularly for minorities, are devastating. Although supposedly imposed by the federal government in response to scientific mistreatment of black individuals, such as at Tuskegee, the very solicitousness of IRBs for minorities stymies research on their distinctive medical problems. …

When government interferes with medical research and its publication—especially when it places administrative burdens on research and publication concerning minorities—the vast costs in human life are entirely predictable and, of course, discriminatory.”

Stifling Political Speach

Hamburger tells the story of Hiram Evans, a 1930s crusader against religious influence on voters and legislators. Evans also happened to be the Imperial Wizard of the Ku Klux Klan. Hamburger classifies Evans’ agitation as an important force behind nativist demands to outlaw religious speech in politics. Ultimately, Congress acquiesced, imposing limits on certain speech by non-profits. Individuals are effectively prohibited from fully participating in the political process through religious and other non-profit organizations by Section (501)(c)(3) of the Internal Revenue Code. Of course, tax-exempt status is critical to the survival and growth of many of these institutions. More traditionally religious individuals are often heavily reliant upon their faith-based organizations not just for practicing their faith, but as centers of intellectual and social life. Needless to say, politics intersects with these spheres, and to prohibit political speech by these organizations has an out-sized discriminatory impact on their members.

The insulation of the AS from the democratic process, and the effective limits on religious speech, often mean there is little leeway or tolerance within the AS for individuals whose religious beliefs run counter to policy:

“The difference between representative and administrative policymaking is painfully clear. When a legislature makes laws, the policies that bear down on religion are made by persons who feel responsive to religious constituents and who are therefore usually open to considering exemptions or generally less severe laws.”

But there are other fundamental biases against religious faith and practices within the AS:

“… when policies come from administrative agencies, they are made by persons who are chosen or fired by the executive, not the public, and so are less responsive than legislators to the distinctive needs of a diverse people. They are expected, moreover, to maintain an ethos of scientism and rationality, which—however valuable for some purposes—is indifferent and sometimes even antagonistic to relatively orthodox or traditional religion, let alone the particular needs of local religious communities.“

Sucking Life From the Republic

The administrative state imposes a variety of economic burdens on the private sector. This is not just costly to economic growth. It also creates innumerable opportunities for rent-seeking by interest groups of all kinds, including private corporations whose competitive interests often lead them to seek advantage outside of traditional participation in markets.

Hamburger’s arguments are even more fundamental to the proper functioning of a republic, but they are probably difficult for many journalists and politicians to fully grasp. He identifies some core structural defects of the administrative state, and he does so with great passion. He sums things up well in his closing:

“… was founded on racial and class prejudice, it is still supported by class prejudice. Moreover, by displacing laws made by elected lawmakers, it continues to discriminate against minorities of all sorts. Along the way, it stifles much scientific inquiry and publication with devastating costs, particularly for minorities. It is especially discriminatory against many religious Americans. And it eviscerates the Constitution’s procedural rights, not least in cases criminal in nature.

So, if you are inclined to defund oppression, defund the administrative state. If you want to tear down disgraceful monuments, demolish the prejudiced and discriminatory power that is Woodrow Wilson’s most abysmal legacy. If you are worried about stolen votes, do not merely protest retail impediments to voting, but broadly reject the wholesale removal of legislative power out of the hands of elected legislators. And if you are concerned about the injustice of the criminal justice system, speak up against the loss of juries, due process, and other rights when criminal proceedings get transmuted into administrative proceedings.

Little in America is as historically prejudiced or systematically discriminatory as administrative power. It is a disgrace, and it is time to take it down.“

Statism and Self-Harm

18 Tuesday Feb 2020

Posted by in Free markets, Government Failure, Uncategorized

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Some have a tendency to think their problems can be solved only through the intervention of some powerful, external force. That higher power might be God, but at a more temporal level, government is often presumed to be a force to fix all things that need fixing. “There oughta be a law” is a gut reaction to things we find injurious or that offend; government has the resources, or the coercive power to get the resources, to undertake big, appealing projects; and of course government has the coercive power to “rearrange the deck chairs” in ways that might satisfy anyone’s sense of justice and fairness, so long as they get their way. Whenever people perceive some need they believe to be beyond their private capacity, or mere convenience, government action is the default option, and that’s partly because many think it’s the only option.

That’s the appeal of “democratic socialism”, to use a name that unintentionally emphasizes a very real danger of democracy: the tyranny of the majority. It’s a dismal way station along the road to serfdom, to borrow a phrase from Hayek.

Government, however, repeatedly demonstrates it’s sheer incompetence and its expedience as a vehicle for graft. And it’s not as if these failures go unrecognized. Everyone knows it! This is nowhere more true than when the state interferes with private markets or attempts to steer the economy’s direction at either an aggregate or industry level. But here we have a dark irony, as told by Nick Gillespie at Reason:

“Again and again—and in countries all over the world—declines in trust of government correlate strongly with calls for more government regulation in more parts of our lives. ‘Individuals in low-trust countries want more government intervention even though they know the government is corrupt,’ explain the authors of a 2010 Quarterly Journal of Economics paper. That’s certainly the case in the United States, where the size, scope, and spending of government has vastly increased over exactly the same period in which trust and confidence in the government has cratered. In 2018, I talked with one of the paper’s authors, Andrei Shleifer, a Harvard economist who grew up in the Soviet Union before coming to America. Why do citizens ask a government they don’t believe in to bring order? ‘They want regulation,’ he said. ‘They want a dictator who will bring back order.'”

Against all historical evidence and forebodings, the wish for a benevolent dictator! As if it’ll be different this time! Are we all statists? Certainly not me, but the Left is full of them. One prominent example is columnist Tom Friedman of the New York Times, who has expressed the sometimes fashionable view that “things get done” under dictatorships:

“One-party autocracy certainly has its drawbacks. But when it is led by a reasonably enlightened group of people, as China is today, it can also have great advantages. … That one party can just impose the politically difficult but critically important policies needed to move a society forward in the 21st century.”

Tell it to the interred Kazakh and Uighur Muslims undergoing “reeducation” in China. The Right has its share of statists as well, and it is typically expressed in desires for enforced social conservatism.

People seem to have a vague idea that everyone else must either be misbehaving or in misery. And despite the well-tested fallibility and lack of trust in government, people persist in believing that the public sector can conjure magic to solve their problems. But the state gets bigger and bigger while solving few problems and exacerbating others. In fact, as government grows, it makes rent seeking a more viable alternative to productive effort. Like the giant zero-sum game that it is, the expansion of government provides the very means to pick away at the wealth of others. When faced with these incentives, people most certainly will misbehave on small and large scales!

The truth is that individuals hold the most potent regulatory force in their own hands: the voluntary nature of trade. It protects against over-pricing, under-pricing, and inferior quality along many dimensions, but it demands discipline and a willingness to walk away. It also demands a willingness to put forth productive effort, rather than coveting the property of others, and taking from others via political action. To paraphrase P.J. O’Rourke, if you think things are expensive now, wait till they’re free!

Who Are the Zero-Sum Winners?

09 Monday Sep 2019

Posted by in Big Government, rent seeking

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Productive effort seldom goes unrewarded, but all too often rewards are directed to nonproductive activities and secured in ways that are outright takings of resources and rights from others. These are zero-sum propositions at best, as the rewards come only at equivalent or greater costs to others. Gains from zero-sum activities are often purely consumptive in nature and tend to foster more destructive behavior. A clear-cut example is outright thievery, but there are many cases in which, by matters of degree, the perpetrators are not even dimly aware that their gains bring harm to others.

Sadly, our society has undergone a transition to a state in which everyone collects ongoing streams of zero-sum rewards, which are, by definition, at someone else’s (and often our own) expense. The turbulence caused by this unnecessary and avoidable mix of costs and rewards is all too real for consumers and businesses, but again, they don’t always fully grasp its dysfunctional nature.

The Way To Positive Sums

Of course, there are winners and losers in almost any area of economic life. Even when two individuals engage in mutually beneficial exchange, an otherwise win-win situation, other traders might regret missing out on the deal. Pleasing buyers more effectively than one’s competitors might force those rivals to turn to other pursuits. That’s all for the best from a social point of view, unless they can come up with an even better idea to win back customers. In this way, things can keep getting better and better for everyone, even for the one-time losers who are free to compete in trades to which they are better suited. Winners, then, are defined by their success in creating value for others. These are the productive winners. But again, material success doesn’t always come so honorably.

Bobbing For Booty?

Purely “consumptive” or zero-sum winners might be simple crooks who are able to avoid apprehension, or perhaps they are dishonest business-people who sell goods with hidden defects or inferior workmanship. There are many degrees here: a talented salesperson with shoddy merchandise might compromise on price. A clever product manager might reduce the size of a package slightly without reducing price.

A simple gamble is zero-sum in a purely monetary sense, but both gamblers do it for enjoyment, so there are psychic gains involved. A successful gambler might be a zero-sum winner in a monetary sense, but luck usually runs out on honest players. A cheater qualifies as a zero-sum winner. Conversely, it’s not correct to say that casinos are strictly zero-sum winners, though the odds are always stacked in favor of the house and everyone knows it. Casino patrons enjoy the experience, including other amusements available in casinos, so they are often happy customers despite their losses. They are engaging in mutually beneficial exchange.

Private Affairs Made Public

A short-hand description encompassing much of our zero-sum havoc is “the public trough”. Many zero-sum rewards have arisen out of legislative battles, court cases, and regulatory actions restricting private decision-making and encroaching on private property rights. The unremitting tendency is for expansion of these kinds of actions. Where there are zero-sum winners at the public trough, or an opportunity to expand the trough itself, there are always more covetous seekers of zero-sum winnings, otherwise known as rent seekers. They are reliable promoters of “do-something-ism” relative to the outrage du jour through more legislation, lawsuits, and regulatory filings. The tragic thing about rent seeking is that the process itself consumes resources and undermines private incentives, thereby transforming zero-sum outcomes into wasteful, negative-sum outcomes.

Winners At the Trough

There are many kinds of zero-sum winners at the public trough. The winning and losing often occur separately and asynchronously, connected only by an enabling authority who sets rules and funds winners from proceeds taken from losers. For this reason, it is easy for citizens to lose track of the “zero-sumness” of the many benefits they receive. After all, the government can deliver things for “free”, right? And the connection between one’s obligations, losses, and the gains reaped by others is not always obvious.

All of the following involve some degree of zero-sum activity, and all attract rent seekers:

  • Public aid in exchange for no contribution to output, funded by zero-sum losing taxpayers.
  • Subsidies for politically-favored technologies that are otherwise uneconomic, funded by zero-sum losing taxpayers.
  • Farm subsidies when too much is produced and the output is not highly valued, leading to an overallocation of resources to agricultural activity and rents for farmers funded by zero-sum losing taxpayers.
  • Complex regulatory and tax rules generate income for compliance advisors such as attorneys, accountants, and consultants. Those are rents, pure and simple, paid for by parties who must comply under penalty of law.
  • Regulatory advantage conferred upon firms sufficiently large or dominant to afford compliance. That penalizes smaller competitors and undermines their market position. The additional profit large firms may earn as a consequence is a rent, funded by zero-sum losing consumers and weaker competitors.
  • The award of government contracts is often as much political as it is economic. Such a process is not subject to the market discipline imposed on private contracts, so there is ample opportunity for rents via cost-padding and graft, again funded by zero-sum losing taxpayers.
  • More generally, government purchases of any kind are subject to weak market discipline, like any buyer spending someone else’s money. Thus, government has a tendency to pay prices not supported by economic value, offering rents to suppliers, funded by zero-sum losing taxpayers.
  • The tax deduction afforded to employer-provided health care is a targeted subsidy that leads employees to over-insure. More fundamentally, these employees and their employers are zero-sum winners. It also creates profits for health insurers and drives up health care costs. The zero-sum spoils are to the detriment of other taxpayers and participants in the individual insurance market.
  • Drug prohibition drives up black market profits, creating zero-sum winnings at the expense and safety of users.
  • Social Security creates zero-sum winnings for those who will not or cannot save. But this is a mixed bag to the extent that some people are unable to save privately: their ability to do so is largely usurped via payroll taxes, both on them and on their employer. The many zero-sum losers would otherwise have no difficulty earning better returns on private investments.

There are many other examples. And almost everyone ends up on one side or the other of many different zero-sum outcomes. Show me a government action and I’ll show you zero-sum winners and losers. This is not to say there are no welfare gains associated with government action. Public aid, for example, is intended as social insurance and surely has some value in mitigating the risks of personal economic calamity. Nonetheless, the overextension and poor incentives of aid programs create a significant zero-sum component. Likewise, government spending on public goods creates social benefits, but government is insufficiently incented to economize, creating a zero-sum win for contractors and losses for taxpayers.

Not Zero Sum

While zero-sum winners collect economic rents, the existence of economic rents does not imply a zero-sum winning. For example, members of the so-called rentier class collect passive investment income. Those investments represent a supply of current resources to other parties hoping to transform them into a greater supply of future resources. That’s productive, and so the gains enjoyed by rentiers are not zero-sum winnings, but payments for the use of transformational capital.

Economic profits are those exceeding the owner’s opportunity cost, and they too are called rents. They should not necessarily be classified as zero-sum gains, however. Only sometimes. Successful innovators and first movers often earn economic profits as a reward for their efforts, as do alert entrepreneurs deploying their resources where they are most demanded. This “positive-sumness” applies to monopolists with a hot product just as surely as it applies to a firm facing nascent competition. But economic profits gained through political connections, outright graft, and government-enabled monopoly are zero-sum, enabled by non-market, authoritarian forces. Members of the political class tend to share in these zero-sum gains, and there are many losers.

Zero-Sum Psyche

Unfortunately, zero-sum thinking is deeply ingrained in the human psyche, despite our transition to a higher plane of social cooperation via markets. Even in those markets, certain outcomes might seem zero-sum in the moment. Witness the widespread denigration of the profit motive, which produces efficient outcomes in the long-run. As noted above, over time, the biggest winners tend to be those capable of creating the most value.

If you ask school children today how to get rich, many will say “win the lottery” without hesitation. I know, I know, government-sponsored lotteries are a relatively new phenomenon, and some of the lottery proceeds may benefit schools or other public programs, but the idea that a game of chance is so indelibly ingrained in the minds of children is a manifestation of the psychology of zero-sum success.

The Tangled Mess

So we have the zero-sum winners: successful gamblers, thieves, and rent seekers. The latter root deeply for gains made possible by government intervention in private affairs, actions that always leave room for enduring rents. They always lobby fiercely for new public interventions that might confer private advantages. And then we have the hapless public, stumbling through a series of zero-sum gains and losses made possible by the Leviathan they know and obey. They should look in the mirror, because every law and every program they have allowed their political leaders to hatch, reliably sold as good and just, creates more zero-sum activity to the detriment of long-term economic welfare. Roll it back!

Corporate Lapdogs of the Left

04 Wednesday Apr 2018

Posted by in Central Planning, Identity Politics, Progressivism, rent seeking

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ceo

Now don’t get me wrong, I definitely prefer to see private goods and services produced privately, not publicly. Private ownership of the means of production makes the world a better place because ownership and self-interest drive performance and value, to put it all too briefly. But corporate America is now so thoroughly encumbered by ideological distractions that it compromises the mission of creating value, risking shareholder returns and invested capital as well. Having spent the past 31 years employed successively by three gigantic corporate hairballs (with a 2-year stint at the central bank), the following thesis about corporate CEOs, and corporate America by extension, strikes me as wholly accurate:

“CEOs … mostly [reject] the ethos of rugged individualism in favor of a more collectivist view of the world. The capitalists [are] not much interested in defending the culture of capitalism. … the psychological and operational mechanics of large corporations [are] much like those of other large organizations, including government agencies … American CEOs [believe] that expertise deployed through bureaucracy [can] impose rationality on such unruly social entities as free markets, culture, family, and sexuality. The supplanting of spontaneous order with political discipline is the essence of progressivism….“

I changed the tenses used above by Kevin Williamson, who attempts to explain why American corporations became such progressive activists. The beginning of the quote describes interviews conducted by William H. Whyte in the 1950s, but it’s as true now as it was then, and probably much more so. The technocratic view of organizational efficacy may be true up to a point. In fact, there is undoubtedly an optimal size for any organization that is dependent upon it’s mission, the technologies at its disposal, and the range of prices it is likely to face in input and output markets. It’s all too easy for a successful firm to expand beyond that point, however, as many now-defunct businesses have learned the hard way. However, the quote merely highlights the sympathetic view often held by corporate managements toward the notion of a planned society, guided by a class of technocrats. They share this scientistic line of thinking with the statist left, though the corporatist vision is a world in which their private organizations play a critical role, with risks mitigated by “partners” in government.

Private incentives can produce wonderful results, but they are corrupted by the scent of private advantage that can be gained via government intervention in markets. The corporate practice of seeking rents through legislative and administrative action has been going on since at least the 1880s, when railroads sought protection from competition and other shipping interests via federal regulatory action.The symbiosis between government and corporate interests, or corporatism, has been growing ever since. Whether it is lucrative contract awards, subsidies, or favorable regulation, government has lots of goodies at its disposal by virtue of its exclusive ability to exert coercive power. This quote of David Cay Johnston describes the end-product of corporate rent-seeking behavior:

“Corporate socialism is where we socialize losses and privatize gains. Companies that have failed in the marketplace stick the taxpayers with their losses, but when they make money they get to keep it, and secondly, huge amounts of capital are given to companies by taxpayers.”

Risk mitigation is at the heart of a second variety of corporate leftism, and Williamson notes the asymmetry in the political risks faced by most corporations:

“Conservatives may roll their eyes a little bit at promises to build windmills so efficient that we’ll cease needing coal and oil, but progressives (at least a fair portion of them) believe that using fossil fuels may very well end human civilization. The nation’s F-150 drivers are not going to organize a march on Chevron’s headquarters if it puts a billion bucks into biofuels, but the nation’s Subaru drivers might very well do so if it doesn’t. … The same asymmetry characterizes the so-called social issues.“

At this point, Williamson goes on to describe a few social issues on which corporate leaders are frequently harangued by the left. Those leaders may view conservative positions on those issues as aberrant, according to Williamson, because the leaders inhabit an insulated world of elitist, media-driven, politically-correct opinion. They wish to be seen as “progressive” and discount the risk of offending conservatives. While I do not take Williamson’s side on all of the social issues he mentions, I concede that there is some truth to the asymmetry he describes.

An avenue through which corporate America is strongly influenced by the left is identity politics. This is partly an unfortunate side-effect of civil rights legislation and other anti-discrimination law, but in today’s litigious environment, there are excessive legal risks against which corporations must take precautions. This is embedded in human resource policies to the point at which hiring the best individual to fill a role is subject to a series of costly, time-consuming hurdles, and is sometimes impossible. Then, there are the mandatory “Diversity and Inclusion” courses that all employees are required to complete. These overbearing attempts to “educate” the work force consume valuable staff time and are of questionable value in light of the aggravation and resentment they inspire in employees. Finally, I can’t keep count of all the corporate-sponsored activities devoted to celebrating one identity group after another. Can we please get back to work?

Today, as a consumer, it is becoming more difficult to engage in commerce without exposure to a seller’s political positioning. For example, I buy about 90% of my clothing from a particular clothier, but last weekend I learned that the company had taken an objectionable position (to me) in the debate over gun legislation. I am certain that activists badgered the company, and it succumbed, and so I will change my shopping habits. People often find that it’s easier to engage in arms-length transactions when the other party stays off the soapbox. But it goes further than that. Here is Williamson:

“Whereas the ancient corporate practice was to decline to take a public position on anything not related to their businesses, contemporary CEOs feel obliged to act as public intellectuals as well as business managers.“

Well, “ancient” might take it a bit too far, but as a customer, employee, and especially as a shareholder, I would urge any company to steer clear of political posturing. Do not dilute your mission of delivering value to customers, which dovetails with serving the interests of shareholders. You must pursue that mission in a way that you consider responsible and ethical, which just might narrow the scope of the mission. And that’s okay. Just be as neutral as possible on extraneous issues as you reach out to potential customers, and do not respond to politically-motivated threats except in the most diplomatic terms.

Should I bother to say that corporations should eschew public subsidies? That they should respond to competition by improving value, rather than lobbying for advantages and protection from lawmakers or regulators? That they should not badger their employees to give to their company’s Political Action Committee (PAC)?

I must be fantasizing! Corporations would never follow that advice, not as long as they can capture rents through the seductive expedient of big government. If that were the only reason for the hate reserved by leftists for corporate America, I’d be right with them. But in fact, leftist rhetoric condemns the profit motive generally, both in principle and as a method of scapegoating for any social ill. Williamson marvels at the incredible irony of the corporate enterprise-cum-lapdog of the Left, which is especially palpable as the Left beats the dog so unrelentingly.

Bankers, Risk and the Rents of Slippery Skin

12 Monday Mar 2018

Posted by in Banking, rent seeking

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Risk taking is important to the economic success of a nation. Creative energy demands it, and it is critical to achieving economic growth and wealth creation. But it’s obviously possible to take too much risk or risks that are ill-considered, and that is all the more likely when risk-takers are absolved of the consequences of their actions. That is, healthy risk-taking and responsibility are inextricably linked. One can’t truly be said to take a risk if the cost of failure is borne by another party. It’s easy to understand why risk-taking becomes excessive or misdirected when that is the case.

Risk Shifting

There are various ways in which a party can parlay risky undertakings into easy gains by shifting the risks to others. For example, any piece of merchandise comes with the risk that it will not perform as advertised. Some traders might be tempted to sell unreliable merchandise and shift risk to the buyer without recourse. This is an area in which we must rely on a bulwark of private governance: caveat emptor. On the other hand, government tends to subsidize risk-taking in various ways: limited liability under the corporate form of business organization, bank deposit insurance, bankruptcy laws, the implicit government guarantee on mortgage assets, and the “too-big-to-fail” mentality of government bailouts.

Whose Skin In the Game?

These are examples of what Nassim Taleb bemoans as the failure to have “skin in the game”. The quoted expression happens to be the title of his new book. I have both praised and castigated Taleb’s work in the past. He made an interesting contribution about the nature and risk of extreme events in his book “Black Swan”, such as his application of so-called “fat tails” in probability distributions, though some have claimed the ideas were anything but original. I was highly critical of Taleb’s alarmist hyperbole on the effects of GMOs. In the present case, however, he considers “the asymmetry of risk bearing” to be a major social problem, and I’m generally in agreement with the point. The most interesting part of the brief discussion at the link is the following:

“In Taleb’s universe, the fieriest circle of hell is reserved for bankers and neoconservatives. ‘The best thing that could happen to society is the bankruptcy of Goldman Sachs,’ he tells me. ‘Banking is rent-seeking of industrial proportions.’ Taleb, who became rich as a derivatives trader, is not a foe of capitalism but of ‘cronyism’. ‘If you’re taking risks, God bless you. This is why I accept inequality. I’ve seen people go from trader to cab driver and back again.’“

Banks are a prominent example of the risk-shifting phenomenon. First of all, banking institutions are not required to hold much capital against their assets. In fact, recently banks have had average equity of less than 6% of assets. That’s much higher than during the financial crisis of ten years ago, but it is still rather thin and hardly represents much “skin in the game”.

Fractional Reserves

It should come as no surprise that a bank’s assets are funded largely by account balances held by depositors (liabilities), and not by equity capital. But your bank balance is not kept as cash in the vault. Instead, it is loaned out to the bank’s credit clients or used to purchase securities. This is facilitated by “fractional reserve banking”, whereby banks need only keep a fraction of their depositors’ money on hand as cash (or in their own reserve deposit accounts with the Federal Reserve). This generally works well on a day-to-day basis because depositors seldom ask to redeem more than a small fraction of their money on a given day.

Reserve requirements are set by the Federal Reserve and range from 0-10%, depending on the size of a banks’ deposit account balances. At the upper figure, a dollar of new cash deposits would allow a bank to extend new loans of up to $0.90. This legal practice divides many in the economics profession. Some believe it represents fraud rather than sound banking. This article by Frank Hollenbeck at the Mises Canada web site states that it is improper for a bank to lend a depositor’s money to others:

“Suppose you lived in the 18th century and had 100 ounces of gold. It’s heavy and you do not live in a safe neighborhood, so you decide to bring it to a goldsmith for safekeeping. In exchange for this gold, the goldsmith gives you ten tickets where eachis clearly marked as claims against 10 ounces. …

… Quickly the goldsmith realizes there is an easy, fraudulent, way to get rich: just lend out the gold to someone else by creating another 10 tickets. Since the tickets are rarelyredeemed, the goldsmith figures he can run this scam for a very long time. Of course, it is not his gold, but since it is in his vault, he can act as though it is his money to use. This is fractional reserve banking with a voluntary reserve requirement of 50%. Today, modern US banks have a reserve requirement of between 0% and 10%. This is also how the banking systemcan create money out of thin air, or basically counterfeit money, and steal the purchasing power from others without actually having to produce real goods and services.”

Another aspect of the argument against fractional reserves is that it creates economic instability, fueling booms and busts as the quantity of money in circulation sometimes exceeds or falls short of the needs of the public. Many authorities have taken a negative view of fractional reserve banking through the years: Irving Fisher, Milton Friedman, John Cochrane, Ralph Musgrave, and Laurence Kotlikoff, to name a few prominent economists (see this recent paper by Musgrave).

In Defense of Fractional Reserves

Others have defended fractional reserves as a practice that has and would again arise in a free market environment. According to this view, depositors would accept the logic of allowing banks to lend a portion of the funds in their accounts in order to generate income, rather than charging larger fees for “storage” and administration. If the depositing public is aware of the risk and has competing choices among banks, then the argument that banks expose depositors to excessive risk via fractional reserves is moot. Fractional reserves can exist in a private money economy in which competitive pressures reward banks (and their privately circulating notes) having sound lending practices. In fact, some would say that the very idea of a 100% reserve requirement is an unacceptable government intrusion into the private relationship between banks and their customers. All of that is true.

Some have compared fractional reserve banking to the sale of insurance. Consumers buy insurance to take advantage of pooled risk, but they have no expectation of a refund unless they incur the kind of insured loss in question. Bank depositors, on the other hand, expect a return of their funds in-full. Yes, low risk is an attribute they desire, and pooling across the withdrawal needs of many depositors is one reason why banks can invest and pass a part of the return on to depositors, both in interest and reduced fees. So, despite the differing needs and expectations of their customers, there is some validity to the comparison of insurers to fractional-reserve bankers.

Amplification of Shifted Risks

Do fractional reserves allow banks to take risks without having skin in the game? Absolutely! With as little as 6% equity at risk, banks have relatively little to lose relative to depositors. Yes, banks pay the FDIC to insure deposits, and premiums are higher for riskier banks. However, not all deposits are insured by the FDIC. More importantly, at the end of 2017, the entire FDIC deposit insurance fund was about 0.7% of commercial bank assets. One big bank failure would wipe it out, or a few hundred small ones. That’s well within the realm of possibility and historical experience. So, where does that leave depositors? Their skin is very much in the game, and the game is about the risks taken by banks in investing depositors’ funds.

We now live in the era of “too-big-to-fail” (TBTF), whereby large banks (and sometimes industrial firms) are viewed as so “systemically important” that they cannot be allowed to fail. Taxpayers must bail them out in the event they become insolvent. Thus, taxpayers have skin in the game. Banks collect rents to the extent that their returns exceed those commensurate with the risks for which they are actually “on the hook”.

Another avenue through which banks off-load risk is the extent to which Fannie Mae and Freddie Mac are still presumed to have the federal government’s implicit guarantee against default on the mortgage debt they purchase from banks. That is beyond the scope of the present discussion, however. And I have not discussed the role of large investment banks in the capital markets. That’s a whole other dimension of the story. This article by Guatam Mukunda in the Harvard Business Review provides a perspective on rent seeking in investment banking.

Conclusion

The combination of deposit insurance, TBTF and other risk-insulating subsidies, layered on top of a fractional reserve banking system, places banks into Taleb’s “fieriest circle of hell”. These factors blunt bank incentives to manage risk effectively as well as consumer incentives to conduct adequate due diligence in their banking relationships. It means that risk is not priced properly, because banks are likely to ignore risks from which they are shielded. Therefore, banks may allocate resources into excessively risky uses. The consequences for depositors and taxpayers can be dramatic.

Fractional reserves are not “fraud” in the sense that the system has unsuspecting victims. Anyone who has watched “It’s a Wonderful Life” knows that banks lend your deposits to others. But fractional reserves magnify the risk-mitigating privileges conferred upon the banking industry by government through various mechanisms. This “risk-cleansing” is converted to rents and collected by banks for their shareholders, but the risks are still borne by society. To the extent that fractional reserves create instability, deposit insurance is viewed as a necessity, but banks should pay a market premium to an insurer to cover the actual risk inherent in the system. Too-big-to-fail should end, as should the implicit subsidy collected by banks through the government-sponsored enterprises.