Snake Oil And The "Science" Of Liberty

A hat-tip to @rorysutherland, who drew my attention to a paper called "The Science of Liberty" by Paul Zak, self-styled "founder in the field of neuroeconomics" with the following tweet on 1 December :

"http://bit.ly/gMGr06 expect to hear a lot more about Oxytocin in marketing writings going forward. This is a good piece."

The paper purports to provide a basis for lighter financial regulation, but ironically points in the opposite direction. It was funded in part by the John Templeton Foundation, a conservative philanthropic organisation, whose President also supports "Let Freedom Ring", the lobbying outfit that also supports the "Tea Party"; and partly by the Gruter Institute for Law and Behavioural Research.

I hope I don't do Paul's reasoning any injustice, but I understand his thesis to be as follows (italics are mine):

• His research found that "a brain chemical called oxytocin (ox-ee-TOE-sin) is released when a stranger takes money from his or her pocket and intentionally gives it to another person in order to demonstrate trust tangibly... the more money the person receiving the trust-denoting transfer receives, the more his or her brain releases oxytocin. Oxytocin levels, in turn, predict how much the second person will reciprocate the first person; that his, how trustworthy she or he will be."
• This process is "nearly impossible to inhibit".
• However, 2% of those studied did not reciprocate, and "there is a technical word in my lab for these folks: "bastards (sic). Not people you want to have a coffee with... On the other hand, two percent isn't bad. It means most people most of the time are trustworthy, and the others can be identified with a slight bit of investigation."
• Participants go out of their way to punish moral violations in the market "when observers of ethical violations are in a position to punish the violators".
• As a result of these findings, Paul argues that "virtue is in fact the very foundation of trade... The market can be fabulously large if most people, most of the time, behave morally, and if their moral tendencies are supported by a legal system in which property rights are protected and contracts enforced."
• Accordingly, Paul asserts that "Economic systems that provide for freedom and limited oversight recognize human dignity and the desire for self-direction."  Such "economies are complex, adaptive, and evolving systems that need no controller. Just a clear set of rules that are enforced by some independent regulatory body."
• "A number of studies have shown that too much oversight crowds out our innate sense of virtue (Gneezy and Rustichini, 2000). A fine for every violation decouples transgressions from the moral violations to a "greed is good" justification. This is Enron and the like" [includes Ford (Pinto gas tanks) and USSR].
• In other words, the Enron scandal was created by overly intrusive regulation, and therefore we should have less of it.

Certainly at this last point the logical elastic band finally snaps.

Ironically, far from presenting a basis for lighter financial regulation, I'm afraid Paul Zak's research into the effects of Oxytocin shows exactly why people need greater protection from the snake oil salesmen, who understand it's effects only too well. The "bastards" are out there, and even two percent of the population means there are actually a lot of them. They can be tough to challenge, especially once they've generated a bandwagon effect. And other market participants are not always in a position to punish these rogues, at least not in time to prevent them doing significant harm - due diligence does not scale well. Finally, Alan Greenspan, former Chairman of the US Federal Reserve advocated light touch financial regulation for 40 years, and lived to regret it:

"In Congressional testimony on October 23, 2008, Greenspan acknowledged that he was "partially" wrong in opposing regulation and stated "Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity — myself especially — are in a state of shocked disbelief." Referring to his free-market ideology, Greenspan said: “I have found a flaw. I don’t know how significant or permanent it is. But I have been very distressed by that fact.” Rep. Henry Waxman (D-CA) then pressed him to clarify his words. “In other words, you found that your view of the world, your ideology, was not right, it was not working,” Waxman said. “Absolutely, precisely,” Greenspan replied. “You know, that’s precisely the reason I was shocked, because I have been going for 40 years or more with very considerable evidence that it was working exceptionally well.” Greenspan admitted fault in opposing regulation of derivatives and acknowledged that financial institutions didn't protect shareholders and investments as well as he expected."

As observed in Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism:

"...[T]the unvarnished invisible hand story, although right in a fundamental way, is wrong at the level of detail and approximation that is necessary to explain what we need to know about macroeconomics.

The old story about capitalism is correct: it gives us what we think we want. But capitalism does not act as its own policeman if we fail to watch over it and give it proper directions. It actively, competitively, seeks the most profit-maximising opportunities. Capitalism will follow such opportunities wherever they lead us...

If [we] are willing to pay for real medicine, it will produce real medicine. But if [we] are also willing to pay for snake oil, it will produce snake oil. Indeed, nineteenth century America had a whole industry devoted to fraudulent patent medicine."

Now, I'm no fan of the Nanny State. I don't believe regulation acts as a market catalyst. And I've written often in support of better regulation rather than simply more of it. It's also clear that the financial regulation spawned by the accounting scandals like Enron failed to avert the latest financial crisis, and is unlikely to avert the next without a fundamental change in the importance that we attach to wealth creation.

But this paper perhaps may serve as further evidence that regulation should be aimed at improving transparency at the point when people first engage with a financial service or its promoter. Simplifying products, documentation and disclosures is critical. Another tactic may be to move away from vertical to horizontal models for intermediation.

More limited oversight is not an option.

Relaxing The Rules: Swinegate Returns

The good citizens of Wales must be very afraid.

On the very day the government re-announced the last government's "Equality Strategy", Ann Clwyd, MP for Cynon Valley, apparently rose to her hind legs and said this in support of relaxing the rules recently passed by MPs to curb expenses abuse:

"During my election campaign, someone came up to me and shouted 'Thief!' and if I had been a man I would have run after him and punched him in the face.”

So Ann clearly reckons it would have been okay for ex-MP David Chaytor to lamp his outraged constituents - at least, presumably before this week's guilty plea - and now the Equality Strategy means there's nothing to stop her 'aving a go...

I empathise with MPs who say they are struggling with legislation that they misconceived in their haste to get re-elected. Really I do. Because you could say that about an awful lot of their output, including their appalling attack on the digital economy in the course of the infamous "wash-up".

But we soldier on without being entitled to run people down in the street and punch them in the face, and so must our MPs - male or female.

There must be limits to the extent MPs can relax the rules for themselves.

Where Will Your Tax Money Go? China?

Here is a fabulous tool to show how the UK Government spends our money. Here is a calculator showing where your own personal tax money goes. And, here is a forum to answer your burning questions around low cost government, waste and efficiency. These are all being developed in the course of the Open Knowledge Foundation's excellent Where Does My Money Go? project.

The forum has already settled a burning question of mine:

"What proportion of government revenue comes from personal income tax, as opposed to corporation tax?"

Answer: In 2008/09, the UK government collected £41.8bn in corporation tax and £149.6bn in income tax.

Together, we and the corporations paid about another £180bn in National Insurance (which of course corporations also pay for employing us) and VAT.

The government recently decided to lower the top-line corporate tax rate from 28% to 24%, and there have been protests about how large UK-based corporations like Vodafone minimise their tax. But I don't really begrudge them that. We need to incentivise private sector corporations to start here, and stay here to employ people and otherwise generate income.

I'm more concerned about how to incentivise ourselves. Corporations tax is a sideshow, compared to the fact that we individual taxpayers, who are effectively banned from incorporating, are supposed to aspire to pouring over 50% of our income into a leaky old public sector bucket - and then fund our own education, healthcare and "retirement" to the very considerable extent that the state cannot be relied upon.

The reason the economy struggles to grow is down to the horrific reality that over half of the country's economic output - and of our personal income - goes to support the public sector, which produces absolutely nothing. Civil servants should not feel slighted by that. As taxpayers they are in the private sector with the rest of us. And they have every right to feel just as alarmed as everyone else, if not more so - especially if they are sitting at a desk doing a non-job. Civil servants are citizens who are being overtaxed to pay for their own net incomes. Weird, huh?

Is this supposed to motivate each of us personally to stay in the UK and generate economic growth? Or is our declining share of income better spent on moving the family to, say, Hong Kong - or, indeed, to Singapore or China, as Jaguar advises, where people save half their income?

The reason that the current government's plans for how to stimulate growth are thin is because the government can't grow the economy. Only the private sector produces growth (though of course the government can be supportive... or not).

This coalition government can't and won't explain all this clearly, partly because it wants our taxes to keep rolling in so it can reduce the deficit in time for the next election, and partly because the Liberal Democrats in the ranks are almost as wedded to 'tax and spend' as their cousins in the Labour Party. Those people think that cutting taxes is "taking money out of the economy". But, of course, lower taxes merely leaves money in the hands of individuals - the private sector of the economy - where the public sector can't get at it.

Here's a growth hypothesis for you: If low income earners were to pay no tax, and others no more than 20% personal income tax/National Insurance plus 10% of income to a UK sovereign wealth fund that invested the money long term; and the administration functions in the public sector were halved, the UK would be growing faster by the next general election than under the current plan.

Discuss.

Image from Joystiq's coverage of tax relief campaign for UK games developers.

Anatomy Of A Dodgy AAA Rating?

Can't wait for a judgment in Cassa di Risparmio della Repubblica di San Marino SpA v. Barclays Bank Plc (Case No. 08-757, High Court, Queen’s Bench Division).

According to Bloomberg, CRSM claims that "Barclays Plc deliberately designed structured notes that would have a much higher risk of default than their triple-A rating suggested" - i.e. "25% or more" instead of “a fraction of 1 percent.”

With any luck, the case won't settle, and we'll have some more forensic insight into the relationship between investment banks and ratings agencies, as well as due diligence and the ratings methodologies...

Lifting The Lid On The EU's Finances

Congratulations to the Financial Times and the Bureau of Investigative Journalism on their exposé on the gross fraud, waste and ineptitude inherent in the EU's €347 billion 'structural and cohesion' funds.

Even putting fraud and waste aside, it's hard to understand how this approach is sustainable if Greece, Ireland, Portugal and Spain are anything to go by. Public sector largesse eventually seems to generate the need for public bail-outs, especially when local governments borrow to match the free money that's available. No wonder the new UK government has put an end to direct local authority funding through this mechanism.

Certainly all this porkbarrelling has done little for 'cohesion'. A recent poll found that only 42% of Europeans trust the European Union - reflecting a general disenchantment with EU institutions over the past few decades.

The seven year budget cycle and lack of provision for returning unspent funds to donor states also makes the scheme incapable of flexing to meet changing economic circumstances. The fact that a large proportion of this money is lying around simply unclaimed in the current environment is scandalous, and another blow to economic confidence.

It's a travesty that this money was raised in national taxes in the first place, let alone handed over to Brussels on the terms of this scheme.

The EU's budget for this nonsense should be slashed next time around.

Image from Forest's Fine Foods.