Monday, August 3, 2009

Wrong Conclusion

Paul Krugman blew it with this one:

Just to be clear: financial speculation can serve a useful purpose. It’s good, for example, that futures markets provide an incentive to stockpile heating oil before the weather gets cold and stockpile gasoline ahead of the summer driving season.

But speculation based on information not available to the public at large is a very different matter. As the U.C.L.A. economist Jack Hirshleifer showed back in 1971, such speculation often combines “private profitability” with “social uselessness.”

Now, you might be tempted to dismiss destructive speculation as a minor issue — and 30 years ago you would have been right. Since then, however, high finance — securities and commodity trading, as opposed to run-of-the-mill banking — has become a vastly more important part of our economy, increasing its share of G.D.P. by a factor of six. And soaring incomes in the financial industry have played a large role in sharply rising income inequality.

What should be done? Last week the House passed a bill setting rules for pay packages at a wide range of financial institutions. That would be a step in the right direction. But it really should be accompanied by much broader regulation of financial practices — and, I would argue, by higher tax rates on supersized incomes.

Unfortunately, the House measure is opposed by the Obama administration, which still seems to operate on the principle that what’s good for Wall Street is good for America.

Neither the administration, nor our political system in general, is ready to face up to the fact that we’ve become a society in which the big bucks go to bad actors, a society that lavishly rewards those who make us poorer.

Letting them gouge us and then trying to get it back is clearly the wrong approach.  We should change the rules so that they don't get it in the first place.

The idea is to set up rules that create a non-zero sum game.  This is an endless process, because every non-zero sum game, pretty much by definition, creates a surplus, and while it's not a definition, I suspect that essentially every surplus attracts a parasite.  Goldman Sachs is clearly a parasite.  You don't deal with a parasite by first letting it feed off of you and then trying to catch it -- that's like becoming a parasite on your own parasite, and is wildly inefficient.  It's better just to not let it feed off you to begin with, at least if you can come up with some way to do this without destroying the surplus on which the parasite lives to begin with. 

There are all kinds of proposals on the table for making the speculation in the financial markets serve a socially useful purpose.  You can have a small transaction tax.  You can clear markets once per second rather than continuously.  You can regulate credit, leverage, and derivatives in a much more thorough manner.  Regulating pay after the fact is the least effective and least transparent means.  It's also not very fair in my opinion, a fact which will undoubtedly be disputed by more than a few readers (ie. all of you).

Incidentally, this is the way I would argue against the proposal that we allow people to sell their votes.  Forget about the morality or democracy and the inalienability of certain rights (which humans have hitherto proved rather expert in alienating of the own free will).  The problem with letting people sell their vote to the highest bidder is not that it is immoral, but simply that it wouldn't work.  Even if I am extremely enlightened and place a very high price on my vote, the person who buys it will always be able to come up with some new tax or law that makes my vote look under-priced in retrospect.  The markets for votes will never reach an equilibrium clearing price.  Similarly, if we continue to let Goldman Sachs profit by writing the rule book, with the notion that we will just take it back in taxes afterwards, we will never be able to raise taxes enough to compensate for the new rules that enable them to further increase their profits.  If you get to write the rules, even a 100% tax is for the little people.

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