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On the ideal/non-ideal distinction in political theory (or, why policy is really hard)

January 21, 2012 4 comments

Something I’ve been meaning to talk about for a while is the ‘ideal/non-ideal’ distinction in political theory. A lot of ink has been spilled on exactly what the distinction is or should be, and up front I will say I haven’t read most of it (I really hope to soon get round to reading my former political theory tutor Lea Ypi‘s new book ‘Global Justice and Avant-Garde Political Agency‘, which has a discussion on the topic. Lea, if I screw this post up in some horribly obvious way – I’m sorry!). But the gist (I think) of the distinction is this: when doing ideal theory, we are thinking about what the perfectly just world would look like. When doing non-ideal theory, we are thinking about what justice demands of us in the imperfect world in which we actually live.

One way of thinking about what we are doing in political theory is that we establish what the ideal is (ideal theory), and then figure out how to make the actual world look as much like the ideal world as possible (non-ideal theory). I have a problem with this way of thinking about political philosophy. And it’s essentially the same problem I have with economic theories that are deduced from assumptions that are unrealistic, and whose conclusions are not backed up through some other methodology. The Lipsey-Lancaster Theorem ( or ‘Theory of Second Best‘) in economics states that when one of the optimality conditions for a theory cannot be satisfied, it does not follow that the that other optimality conditions still hold. That is to say, if your proof that x is optimal requires y and z, and y does not hold, it is not necessarily the case that the best alternative to x has z as an optimality condition. When I first read the paper, by Richard Lipsey and Kelvin Lancaster, my mind was blown. But it’s just a particular instance of a very general phenomenon: that when you have a deductive  argument following from certain premises, and then weaken one of the premises – all bets are off. It may be the case that a weakened premise can still support a weakened conclusion, but it’s equally possible that nothing follows at all.

I think this relates directly to the ideal/non-ideal theory question, because once you have weakened one of your assumptions about , say, what people are actually like (or especially what people can know, which is almost always ignored) then it just doesn’t follow that moving the world towards something more closely approximating the just world (as derived from ideal premises) is actually what justice demands of us. I take this to be a simple point of logic.

I think this can make the question of advocacy really difficult. If there is anything I have ever learned, it is that often an ‘answer’ to a problem requires a number of distinct elements in order to work. Once you take one of those elements away from me, I have to completely rethink what the right answer is (I find this to be especially true when thinking about financial regulation). If my ‘ideal’ answer would be a world featuring x, y and z, and I can’t have z, it simply doesn’t follow that I should still want x and y. X and y might be a deadly combination on their own! (For example, read x as ‘capital requirements for banks based on risk-weighted assets’, y as ‘having ratings agencies assess the riskiness of assets for regulatory purposes’ and z as ‘competition and competence in the ratings agency business’. We didn’t have z, and it worked out really badly). This means that people can so easily end up talking past each other, because they have different implicit assumptions as to what possibilities are allowed within the particular ‘non-ideal’ rules of the debate.

Of course, too often I use this as an excuse to be lazy about advocacy. I definitely have a tendency to go too far in the sceptical direction, and just throw my hands up in the air and say I have no idea what to do (although when it comes to effectively relieving deprivation, I generally trust GiveWell). But maybe I see difficulty where there is none. If that is the case, I would very much like to know.

Categories: Philosophy, Policy

A modest proposal on climate change

December 23, 2011 1 comment

There are, as I see it, two really big and profound problems with the way we’ve gone about trying to reduce greenhouse gas emissions. The first is that at the level of the individual, it is surprisingly complicated to figure out how you can minimise your own carbon footprint. For electronic products, it has been argued that carbon footprint is actually impossible to measure. I doubt most people understand the massive carbon savings of buying a fuel efficient used car, rather than a new hybrid. It is completely unreasonable to expect people to make these calculations for everything they buy. Furthermore, merely making low-carbon options available to people will not in and of itself do much to reduce emissions from current levels, for essentially the same reason that increasing road capacity or even other forms of transportation doesn’t reduce congestion. It’s all about the price of the thing you are trying to get rid of – hence why congestion charges have worked to reduce traffic in places like London and Stockholm, and merely building new roads hasn’t worked anywhere.

The second problem is that the way we’ve been going about trying to reduce emissions – getting governments to agree on targets by some date – creates an enormous incentive to negotiate down the size of your particular countries emissions, and then to cheat on it. This is because there is an economic cost to doing this, and merely trying to achieve it through blunt regulatory mechanisms means that it is attractive for any individual country to cheat a little, and reduce the cost of doing carbon-emitting business there. You can think of it as a kind of carbon cartel, and is subject to all the problems that bedevil cartels – and more, because limiting production doesn’t give you any tangible monopoly rents. it doesn’t take a genius to realise that if this is the best we can come up with, then we’re completely screwed.

Thankfully, I think there is a solution to this that covers both these problems. My modest proposal would be to eliminate all taxation and replace it with a carbon tax, assessed at the earliest possible point in the production chain (i.e. energy produced within the country, and the carbon footprint of all imports). In order to account for the fact a carbon tax is more regressive than current taxation, I’d establish a citizen’s income. As the amount of carbon used within the country naturally falls and the tax revenue with it, I would replace the lost revenue with a gradual phase-in of the previous tax regime*.

The beauty of this plan is that it will result in individuals re-allocating towards a consumption basket lighter on carbon, merely through the fact carbon has become really expensive. No one has to calculate the carbon footprint of anything (other than imports), because the price of the carbon will be passed down from point where it was assessed into the prices of final goods. Hayek was very wrong about some really important stuff, but his idea that prices reflect information that would otherwise be incalculable to individual agents is one of the most brilliant insights of the last 100 years.

Furthermore, whilst this plan would be terrible for carbon-intensive industries (as it ought to be), if you were the only country to do this then every low-carbon business in the world would want to re-locate to your country. Whilst ‘competitiveness’ on the carbon front would be terrible, for every other kind of economic activity you will have to put the ball in everyone else’s courts in order to make low-carbon industries more attractive in order to prevent them moving. In short, I think my proposal has a healthy rather than perverse ongoing dynamic, by taking what is currently a race to the bottom (countries trying to shirk their obligations) and turning it into a race to the top (through incentivising low-carbon business and industry).

I haven’t thought through all the aspects of this yet. It’s just something that has been stewing in the back of my mind for a while, warmed by my deep dissatisfaction with all the ‘solutions’ people have been talking about. I’m not in a position to comment on how worried we should be about climate change, but if we ought to be as worried as the experts seem to be, then we need to start coming up with ways to drastically reduce our carbon emissions that will actually work. There is something in my plan for everyone… other than industries that heavily rely on carbon emissions. Given that the professional consensus among economists is that consumption taxes are the most efficient, I really struggle to think of any economist who would prefer the current tax regime to this.

I don’t in any way see my ‘plan’ as anything remotely close to a finished product, and I’d really like to hear people’s reactions to it. But it does seem (at least to me) to be a lot better than anything anyone else is talking about.

 

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*I say this just to make it less controversial. In reality, I also hope it would lead to a vigorous debate as to how we should reconstruct the tax code from scratch. Conservatives, you should absolutely love this part

 

Categories: Policy

Politics isn’t about policy

December 15, 2011 2 comments

[Update: in a massive "D'oh" moment, even though it's pretty unclear to me whether the structural deficit provision of the accord applies only to Eurozone countries or all signatories, obviously the BBC article I quoted completely contradicts my position. Overall the reports I've found are conflicting (really surprised how hard it is to get this straight), and I formed the argument in this post on the basis of an impression that the budget provisions would apply to all signatories, as this would explain why it would be controversial in the non-Eurozone countries such as Sweden and Denmark. I then somewhat unthinkingly pasted in the BBC version of events because, well, it was the BBC. If you can enlighten me as to the truth, please do.]

I’m not usually one for following the verbal sparring of parliamentary politics, because I value my sanity. I would like to point out that I was not motivated to write this in order to single out a particular side, but rather this is just something I happened to pick up on (and people who know me well will be aware of my near total contempt for almost every political party). Earlier this week, Leader of the Opposition Ed Miliband attacked Cameron for his veto of the proposed revisions to the Lisbon Treaty:

Here’s the truth: last week he [Cameron] made a catastrophic mistake

I would simply like to point out one of the provisions of the agreement

  • a commitment to “balanced budgets” for eurozone countries- defined as a structural deficit no greater than 0.5% of gross domestic product – to be written into national constitutions (emphasis mine)

And compare it to something I found on the Labour Party’s website back from a couple of years ago

  • we have set out clear plans to reduce the majority of the structural deficit over the course of the next Parliament – falling from 9% of GDP this year to 3.1% in 2014/5  (emphasis mine)

And then compare Ed Miliband just four weeks ago in anticipation of the Autumn budget statement , on the coalition government’s relatively aggressive deficit reduction plans

It will be the moment that we learn that the biggest economic gamble in a generation has catastrophically failed (emphasis mine)

I’m not saying Cameron wielded the veto for the right reasons – I simply don’t know the facts (although what I will say is that the big European countries have consistently shown that they will regulate in such a way as to coddle their larger and more leveraged universal banks). Furthermore, every other European leader has a huge political incentive to shift the blame onto someone else if they can. But if Miliband thinks Cameron should have gone along with the accord, then he’s saying that Britain* should enshrine in constitutional law(!) the very kind of deficit reduction requirements that he simultaneously believes to be so catastrophically dangerous.

Seriously, is there no one in this country who can say anything about Europe that isn’t either daft, xenophobic or in complete contradiction to everything else they ostensibly believe in? Because it sure does seem that way most of the time.

Robin Hanson is almost certainly right – politics isn’t about policy. Sigh.

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*As I said in the update, I could be quite wrong to think that Britain would have to go along with this part of the agreement. The lukewarm response in the non-Eurozone countries suggests yes, that Cameron didn’t say he vetoed it for this reason suggests no. Either way, the Labour Party’s position ought to be that this is a giant mistake (if they want to be consistent).

Categories: Economics, Policy

Thinking clearly about wealth – antibiotics edition

November 12, 2011 1 comment

I’ve experienced a massive surge in my blogging productivity recently, driven by a) figuring out I could write emails to myself on the train to and from work and then publishing them when I get home, b) going from 5-10 hits per post to 50-100 which seems to have energised me somewhat and c) friends and others saying very nice things about what I’ve been writing. So thank you all for your support, and I hope I can keep the quality (and your interest) high.

[now resuming regular programming]

This morning, I was re-watching the short presentations given by a number of my favourite bloggers at the Kauffman Institute back in April. All the talks are available online, and all are worth watching (only 5-15 minutes each). But the one that stands out in particular for both importance as a topic and incredibly astute analysis is Megan McArdle on antibiotics, which she calls in one of her slides “The world’s most broken market”. I highly recommend you watch the presentation and read her post at The Atlantic on the same topic.

Her point got me thinking about something I wrote a couple of weeks ago. In my post on the 99% meme, I said this

… if I had decided to do a Philosophy PhD instead of being a consultant and had zero income, I would still have had the option to take a high-paying job. That option is a form of wealth, even if I had chosen not to exercise the option.

I’m starting to come to the view that what matters from the standpoint of living standards is not income, but wealth. But when I say that wealth is what matters, I mean to construe it extremely broadly. One of the problems with the market for antibiotics is that our over-consumption is reducing the chance that we will be able to purchase antibiotics in the future which successfully treat disease. Knowing how to make pills in large quantities that can successfully fight disease is one of our most valuable assets, but the consumption of antibiotics reduces the value of that asset by increasing resistance. It’s capital depreciation.

Can you really imagine a world without bankable, go-to antibiotics? Here are some of the consequences Megan lists

  • Without antibiotics, there would be very little elective surgery.  Before sulfa drugs, surgery was a very serious business with a high risk that a patient might die of some complicating infection.
  • Without antibiotics, forget organ transplants.  The immune suppression would almost certainly be fatal in a pretty short time period.  HIV would also be more dangerous.
  • Without antibiotics, retirements would get shorter again. Before antibiotics, the average 60 year old who caught pneumonia was more likely than not to die of it than not.  That’s why they used to call pneumonia the “old man’s friend”.  Nor is pneumonia the only potential killer.
  • Without antibiotics, maternal mortality would be a lot higher.  So would mortality from abortions, dramatically. While backalley abortions were horrible, and did kill people up until legalization, the theatrical figures thrown around by the pro-choice movement were mostly due to the lack of antibiotics, not the butchery of the freelance abortionists.  Between 1936 and 1960, the number of deaths from abortions seems to have fallen by something between 80-95%.  Looking strictly at mortality, you’d probably be much better off getting an illegal abortion with antibiotics than a legal one without.
  • Neonates would also be much more likely to succumb to infection, since their immune systems are underdeveloped.
  • Chronic infections can lead to various sorts of cancer (H. Pylori, the bacteria that causes ulcers, also causes stomach cancer).  These would take more people before they got Alzheimer’s.
  • The severely disabled would have much shorter life spans.  Without antibiotics, there would be no way to treat the bed sores, or the lung and urinary tract infections that are common for people with limited sensation or mobility.
  • Strep and its evil cousins, scarlet and rheumatic fevers, would once again be a major killer and disabler of children.

I’d also add onto that list the fact that a reduction in infectious disease-fighting capital has consequences for one of humanity’s most successful innovations for increasing productivity and living standards: cities. The intermingling and interbreeding of ideas, the relative ease with which you can build organisational capital, sufficient economies of scale for niche goods and activities that small numbers of people value very highly… all these things and more cities bring to the world. But if that world is without antibiotics, cities become a relatively more dangerous place to live*. And that is not good for our future economic prospects.

Wealth of this kind cannot be measured, and ‘assets’ of this kind cannot be identified as anything other than abstract entities; theoretical leftovers of grossly simplifying economic models of reality. But that does not mean that they aren’t some of the most valuable assets we have. Thinking about wealth more broadly is, I would claim, a necessary condition of correctly identifying where our energies ought to be directed when it comes to evaluating and agitating about public policy.

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*Think of it this way, cities might still increase our productivity, but city dwellers would be subjecting themselves to massive tail risks

We need to change the way we do financial regulation

November 9, 2011 3 comments

In between pondering the potentially disastrous consequences of Italy entering the ‘Danger Zone‘ on their debt yields, I have been thinking more about what I wrote on Monday about financial regulation. There is a kind of basic dilemma that is very difficult to avoid; we tell banks that they must have this much capital or this many liquid assets, but what are the consequences if they don’t? Well, the whole point of a rule is that it needs to be enforced. The banks must be induced to have at least x% Tier-1 capital, or a y% liquidity coverage ratio, by creating consequences if they don’t. But in order for the consequences to be an incentive against breaking the ratio, they must be bad consequences for the bank (otherwise there is no inducement). Regulatory rules such as capital ratios may increase stability during normal times, but can end up destabilising financial institutions when they are at their most fragile.

Simply put, if you have a rule then there have to repurcussions for breaking it (otherwise, why not break it?). But the times when the banks are put under pressure by the rule is exactly the time you least want them to have to take some kind of prompt corrective action. Financial markets in a world with leverage and maturity transformation have some inherently unstable features, and we need to come up with regulatory mechanisms that counteract  rather than compound those instabilities.

As I said on Monday, I do think a CoCo-type plan has promise (more on that here) because the mechanism that kicks in when the rule is broken looks to be stabilising whilst also punishing the bank’s shareholders. I shall continue to ponder.

Categories: Economics, Policy

Should we use market indicators for bank capital regulation?

November 7, 2011 3 comments

Kenneth Rogoff makes an interesting point on the ‘Too Big To Fail’ problem:

There is this view that if we can just break up the big banks into smaller ones, we won’t have a problem. But if you look at systemic crises, usually a lot of banks are doing the same thing. So if we take one big bank and break it up into ten smaller banks that act similarly, I’m not sure how much we really would have bought ourselves. The incentives that would make a big bank go whole hog in one direction would probably make ten smaller banks do the same thing.

Rogoff is absolutely right to say that solving TBTF is not a sufficient condition for a robust financial regulatory system. I would however contend it is a necessary condition – if we could find a way to ameliorate the incentive to herd, then ten smaller banks would be less systemically risky than one. If we can’t think of a way of doing this, then it is probably the case that the battle to rid ourselves of TBTF would be a waste of political capital.

However, I have a germ of an idea for how we might be able to make the incentive issue substantially better. There is (to my mind) an enormous flaw in the way we regulate financial institutions, which is that in order to calculate bank capital ratios, we compare bank capital to risk-weighted assets. Now, there were excellent reasons why this was introduced in Basel II and it is of course completely correct to look at the riskiness of the asset portfolio when considering the appropriate amount of capital to hold. But the problem is that if a particular asset class has its risk underestimated by whatever mechanism is used to determine regulatory risk-weighting (e.g. ratings agencies) then you essentially end up incentivising  banks to load up their balance sheet with that asset class. Therefore, a regulatory system that uses risk-weighted assets is going to lend itself to the kind of herd behaviour that Rogoff is referring to.

Thankfully, there may be an alternative. As I was discussing all manners monetary and regulatory over lunch with a colleague (as one does), I recalled a fascinating speech by Andrew Haldane – Executive Director for Financial Stability at the Bank of England – that I first read a while ago. Specifically, I remembered the following charts. The first is a chart of the regulatory Tier-I capital ratios of “crisis” and “no-crisis” banks* over time. In celebration of the fact I just figured out how to put images on my blog, here it is:

What this graph shows is that a banks regulatory capital ratio was not a predictor of whether or not it would be a ‘crisis’ or ‘no-crisis’ bank. However, what was really interesting was how market indications of bank’s capital positions appear to have been somewhat predictive of problems before 2008:

This strongly suggests to me that a simple market-based ratio is superior to the highly complex regulatory calculations required by Basel III. And I think it would be a good step towards solving the herd problem, as it would encourage banks to form their own individual views about which risks are priced appropriately in the market, rather than all crowding towards a regulatory-induced mispricing.

Of course, in these situations one must always be wary of Goodhart’s Law, and it may be the case that adopting a rule of this kind would change the relationship between the variables (it may require extra vigilance on the topic of bank disclosure, given the relative increase in importance of them for regulatory purposes). This is certainly worthy of further investigation, and I would also be very keen to see the variation within the two average lines on the charts. Haldane’s proposal in the speech, to mandate bank issuance of ‘CoCo’ bonds which would convert from debt to equity upon passing a market trigger based on an indicator such as those in the above charts, is the best idea I’ve come across so far for a ‘bail-in’ rather than ‘bail-out’ strategy.

However, the bottom line is that a regulatory mechanism that relies on market indicators rather than regulatory risk-weighting should go some way towards reducing the herd effect, and would help make TBTF a problem worth solving.

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*’Crisis banks’ are RBS, HBOS, LLoyds TSB, Bradford & Bingley, Alliance & Leicester, Citigroup, WaMu, Wachovia, Merrill Lynch, Freddie Mac, Fannie Mae, Goldman Sachs, ING Group, Dexia and Commerzbank. ‘No-crisis banks’ are HSBC, Barclays, Wells Fargo, JP Morgan, Santander, BNP Paribas, Deutsche Bank, Credit Agricole, Societe Generale, BBVA, Banco Popular, Banco Sabadell, Unicredit, Banca Popolare di Milano, Royal Bank of Canada, National Australia Bank, Commonwealth Bank of Australia and ANZ Banking Group.

Categories: Economics, Policy

Why good monetary policy is like good crime fighting

November 6, 2011 370 comments

(This post is riffing on a theme that Nick Rowe and Lars Christensen have been discussing recently. I hope they don’t mind…)

Imagine that instead of enforcing ‘laws’ that you could find in a rulebook or constitution, the police and judges decided to instead arrest, charge and imprison people for actions that they considered to be detrimental to society. Leaving aside for one second the fact that this would be grossly unjust, I want to focus on the fact that this would require a lot more policin’ and judgin’ than takes place in a society with proper rule of law. Why? Because whilst people can make an attempt at inferring what is or is not ‘illegal’ in this society, they can’t really be sure whether what they do will be punished by the system or how severely. Given that the reason we have to prevent crime is because people want or need to do it for one reason or another, you would end up with more people committing crimes than you do than under rule of law. There is less deterrence, and the criminal ‘justice’ system in this society would have to do a lot more work in order to achieve its objectives.

The reason I bring this up is because the Federal Reserve is to monetary policy as the justice system is to crime fighting in the society I just invented. If the Fed wants to create, say, 5% NGDP growth but doesn’t tell anyone that’s what it is doing, then it has to do a lot more work in order to create that outcome. Why? Because if the Fed was making a credible threat to do what was necessary in order to generate the desired outcome, then people would conduct business in such a way that is consistent with the desired outcome, just as tempted (or simply otherwise unaware) potential ‘criminals’ under rule of law are more likely to act in a way that is consistent with low crime. This is why the Swiss National Bank announcing it would do whatever it takes to maintain an exchange rate floor with the Euro has resulted in it making smaller purchases of Euros than before the announcement. The reason why the Fed has had to take so much ‘drastic’ action is because no one is really sure exactly what outcome it is trying to achieve. People are essentially placing their bets all over the place with regards to inflation and nominal expenditure, with the Fed having to then step in to correct for the effects that creates on whatever its actual (secret) target is. I’m strongly in favour of NGDP level targeting over the inflation rate targeting we have here in the UK, but an explicit inflation target would be an improvement over the current situation (although not commensurate with the Fed’s dual mandate for low unemployment and inflation. Just another reason to select some kind of nominal expenditure variable).

But I want to come back to the rule of law point. Conservatives and progressives have vastly different reactions about a monetary response to the crisis, as higher than expected inflation ‘punishes’ savers and creditors (a more conservative constituency). But the point is that both the creditor and the debtor entered into a contract (featuring a nominal variable) with some kind of expectation about future inflation. In a society with a credible central bank targeting either prices or nominal expenditure, there would be a baseline by which a claim of ‘favouritism’ towards debtors or creditors through monetary policy could actually be adjudicated. If the Fed says it’s going to ensure 2% inflation and it ends up being 5%, then that is unfairly ‘favouring’ debtors over creditors based on the context under which they entered the contract. But at the moment, it is near impossible to say what is or isn’t fair on debtors or creditors as there is no explicit target.

That central banking with a transparent target is better economically is one excellent reason to adopt it. The fact that it is also, as I would like to term it, the ‘rule of law’ policy is a very happy coincidence.

Categories: Economics, Policy
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