Political Order and Political Decay

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That is the title of Francis Fukuyama’s latest book. I have started reading it. So far, I would summarize it as saying that government must overcome both market failure and government failure. That is, it needs to be effective at providing public goods while serving everyone equally (not succumbing to the problems of public choice). I might summarize this as follows:

Public Goods Provided Public Goods Not Provided
Treats People Equally good government weak government
Privileges Elites crony government predatory government

Think of Denmark as good government, China as crony government, Zaire under Mobutu as predatory government, and Afghanistan as weak government. I assume that “political decay” will mean the movement from good government toward either weak government or crony government.

For a review by someone who has finished the book, see Michael Barone.

Better than HBR on Two-sided Markets

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Jean Tirole and Jean-Charles Rochet wrote,

The starting point for the theory of two-sided markets by contrast is that an end-user does not
internalize the welfare impact of his use of the platform on other end-users.

If Anita’s attendance at the singles bar would attract more men, then Bonnie, Christine, and Debbie should subsidize Anita’s attendance. (Similarly, Anita should want to subsidize the others.) But the transaction costs of doing this are high compared to having the singles bar do the subsidizing. On the other hand, at a brothel, the same externalities do not apply.

“Scott Alexander” on Political Tribalism

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He writes,

How did both major political tribes decide, within a month of the virus becoming widely known in the States, not only exactly what their position should be but what insults they should call the other tribe for not agreeing with their position?

Pointer from Tyler Cowen.

Of course, my answer to his question is in The Three Languages of Politics. What Alexander calls the “red tribe” narrative does indeed have a civilization-barbarism feel, and what he calls the h”blue tribe” narrative has an “oppressor-oppressed” feel.

Anyway, read the whole piece. Another excerpt:

Daily Kos or someone has a little label saying “supports liberal ideas”, but actually their incentive is to make liberals want to click on their pages and ads. If the quickest way to do that is by writing story after satisfying story of how dumb Republicans are, and what wonderful taste they have for being members of the Blue Tribe instead of evil mutants, then they’ll do that even if the effect on the entire system is to make Republicans hate them and by extension everything they stand for.

Note that on the issue of a quarantine of countries where Ebola has broken out, the three-axes model might predict that if Ebola had broken out among Jews in Israel instead of in West Africa, there might well have been a reversal in which tribe favored quarantine. The “conservative germophobia” theory would predict otherwise.

PSST–it’s Bananagrams

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The game Bananagrams may be a good metaphor for patterns of sustainable specialization and trade. In the game, each player is dealt a bunch of tiles with letters on them, like Scrabble tiles. You play as in Scrabble, but without a board and with each player playing his or her tiles alone. You form words free-form, but they must all connect, as in Scrabble. The object is to use all of your tiles. The rules are such that as the game proceeds, you are often forced to draw a new tile before you have used all of your tiles.

Sometimes, you have most of your tiles connected, with very few “unemployed” tiles, and when you get a new tile you can quickly “employ” it, meaning that you can add it to your existing set of words. That situation would represent a high-employment economy with patterns of sustainable specialization and trade.

However, sometimes you get a new tile, or a few of them, and you realize that you cannot make use of these tiles without breaking up several of your current words and starting over. You might be down to just one or two “unemployed” tiles, but breaking up some of your words gives you many “unemployed” tiles. That situation represents an economy where patterns of specialization and trade have become unsustainable. Getting back to a high-employment situation takes time and trial-and-error, just as in Bananagrams it takes time to recover when you find that your current word pattern won’t let you use all your tiles and you need to break up some of your words and create new words.

Clarify the Connection

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1. Melinda Pitts, John Robertson, and Ellyn Terry have a chart that seems to me to show that much of the decline in labor force participation in recent years can be accounted for by population aging, disability, and young people attending school.

Pointer from Mark Thoma.

2. James Pethokoukis has a chart showing that the number of people on food stamps has remained really, really high.

I would interpret (1) as saying that we are in a “nothing to see here, move along” sort of labor market. Given that the unemployment rate is normal, if labor force participation is just following natural demographic trends, then the economy is pretty much ok.

I would interpret (2) as saying that there is something to see here. With unemployment down, we should be seeing people fall off the food stamp rolls.

Are senior citizens, people on disability, and young students going on food stamps in droves? Are people who are still in the labor force and working staying on food stamps in droves?

I am not trying to make a point. I genuinely do not know how to connect these dots in the data. For those of you who follow algebra, we have

FS = food stamp recipients
POP = total population
UNEMP = employedunemployed
LF = Labor force

Then FS/POP = (LF/POP)(UNEMP/LF)(FS/UNEMP). We know that FS/POP is unexpectedly high, but LF/POP is low, and UNEMP/LF has come down. So FS/UNEMP must be quite high, right?

Clarify the Counterfactual

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Neil Shah of the WSJ writes,

If Census were to exclude Social Security benefits from income, the poverty rate for American seniors would jump from 14.6% to a whopping 52.6%—roughly 23.4 million people.

Consider three counterfactuals.

1. The government makes a sudden, surprising decision to renege on promised SS benefits.
2. The government tells all young people that SS is abolished for them, and they are on their own in terms of planning for their retirement.

The analysis of the Census data tells you what is probable under (1), but that is not a terribly interesting scenario for policy purposes. The interesting policy scenario is (2). In that case, when the hypothetical young people retire, their poverty rate could be either higher or lower than under SS, depending on how much they save and how well they invest that money.

The Problem of Big Banks

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Stephen G. Cecchetti and Kermit L. Schoenholtz write,

Imagine the following simple approach (like that of Acharya et al). Let the capital structure of a bank’s long-term liabilities be clearly stated and then honored if and when necessary. That is, think of the bank as having a hierarchy of long-term debt ranging from the most senior (call it tranche A) to the most subordinated (tranche Z for zombie!). Whenever a bank’s capital position is deficient – say, because the market value of its equity sinks below a threshold ratio to its book assets – the resolution authority automatically makes some of the debt into new equity, starting with the Z tranche and then climbing up the alphabet until there is sufficient capital to return the bank above the regulatory minimum. Provided that there is sufficient long-term debt to absorb the losses, the concern remains a going one. (The resolution authority could still replace management and shut down risky activities in an effort to prevent a serial failure.)

Pointer from Mark Thoma. This is an alternative to the idea of divesting the firm’s assets according to a “living will.” The authors write,

But let’s not overstate the attractiveness or simplicity of the phoenix plan. No scheme can eliminate policy discretion, as crises often lead governments to change the rules on the fly (think of the 2008 TARP legislation that followed the failure of Lehman).

The way I read this, we really cannot get back to the rule of law if we have too-big-to-fail banks. That is what I will be arguing in two weeks. These institutions will be given special treatment, particularly in a crisis. In 2008, AIG was eviscerated in order to provide a liquidity injection to Goldman Sachs, Deutsche Bank, and others. Does anyone think that the decisions would have come out the same if the Treasury Secretary had been a proud alumnus of AIG rather than of Goldman Sachs?

Some of my other thoughts for the panel.

1. Suppose that we were to limit any financial institution to $250 billion in liabilities that are not backed by capital. Currently, the largest banks in this country seem to have over $1 trillion in liabilities.

2. What can you not do with a $250 billion portfolio? What would such a bank be precluded from doing, other than buying another huge bank?

3. I think it is pretty hard to know for certain the extent of economies of scale and scope in banking. However, my intuition is that the big banks did not get where they are today through natural market competition. In other industries, dominant firms are characterized by focused excellence. Intel is very good at designing and manufacturing chips. Walmart is very good at logistics. What is JP Morgan Chase very good at? Citigroup?

Another characteristic of dominant firms in competitive markets is that they grow by doing more of what they are good at. In contrast, banks grow primarily through mergers and acquisitions.

4. How much does too-big-to-fail matter? Well, try to imagine what the computer industry would look like if the government had designated the dominant firms as of 1970 as too big to fail. We would still have Wang and DEC, but I doubt that we would have Apple or Microsoft.

5. If we imagine banks without TBTF, then it is likely that at times in the past the stock prices of some of the large banks would have been very low, which would have halted their growth through acquisitions and perhaps forced management to divest poorly-managed business lines in order to appease shareholders.

We cannot have large banks without TBTF. We cannot have TBTF without an unfair playing field and mockery of the rule of law. So we should break up large banks.

Teenagers in the Court System

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Jan Hoffman’s post

What none did, however, was exercise his constitutional rights. It was not clear whether the youths even understood them.

Therefore none had a lawyer at his side. None left, though all were free to do so, and none remained silent. Some 37 percent made full confessions, and 31 percent made incriminating statements.

These were among the observations in a recent study of 57 videotaped interrogations of teenagers, ages 13 to 17, from 17 police departments around the country. The research, published in Law and Human Behavior, adds to accumulating evidence that teenagers are psychologically vulnerable at the gateway to the criminal justice system. Youths, some researchers say, merit special protections.

reminded me of a personal experience when I sat on a jury.

At a cognitive level, the video of the detective and the defendant showed an incriminating confession, obtained by the book, without threats, intimidation, or promises. At an emotional level, it showed a teenage boy, in an awful mess, with no adult there to help him. He was polite, and almost endearing. The majority of jurors had children, and the main effect of the video was to trigger our Parent Reflex. In our particular courtroom drama, the role that many of us chose was that of the defendant’s Surrogate Parents.

It was a traumatic experience, and we let a guilty young person off. Go back and read my whole essay.

Thoughts on Two-Sided Markets

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Lynne Kiesling writes,

the distribution wires firm can, and should, operate as a platform and think about platform strategies as the utility business model evolves. An electric distribution platform facilitates exchange in two-sided electricity and energy service markets, charging a fee for doing so. In the near term, much of that facilitation takes the form of distribution, of the transportation and delivery. As distributed resources proliferate, the platform firm must rethink how it creates value, and reaps revenues, by facilitating beneficial exchange in two-sided markets.

Until now, I have not thought much about this whole two-sided market concept. I am struggling to see what it buys you. Earlier in her post, she quotes from a Harvard Business Review article.

In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side. The platform incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized

If I’m understanding this correctly, then a brothel is a traditional value chain, but a singles bar is a platform. In terms of that metaphor, Kiesling is suggesting that electric utilities could change from operating like brothels to operating like singles bars.

Some problems I am having:

1. I am not sure what, if anything, makes brothels the natural business model in one industry and singles bars the natural business model in another.

2. Suppose that a singles bar has to pay women in order to get them to show up. By my reading of the HBR excerpt, then it becomes a traditional value chain. Metaphorically, it becomes a brothel, although I assume that it can avoid legal difficulty as long as the beds are off premises.

3. To me, cable TV looks like a brothel, not a singles bar. And to me, electricity looks like cable TV.

4. Metaphorically speaking, taxi companies and hotels operate brothels. Uber and airbnb operate singles bars. What Uber and airbnb are tapping into is supply-capacity that taxi companies and hotels were not using, either because they didn’t think of it or because it didn’t fit their business model. Is there spare electricity-generating capacity that utilities could be tapping into? If so, do they have the know-how and flexibility to tap into it?