Businesses are People, too

So, I’m back. We’ll see how often I can keep this up. There may be blog posts at 3am while feeding babies. I’m just sayin’.

To the topic. This is a terrible idea. SiezeBP.org is a website which is advocating the following:

YES, I support the seizure of BP’s assets to provide comprehensive compensation and relief for all affected people and for cleaning up the environment.

Seem like a good idea? Here’s the problem: Businesses need a rule of law in which to operate just like people do. While I will never say that Obama is a socialist, I do wonder sometimes if he and others on the left miss this point. Let’s see if I can elaborate.

Most people (especially on the left) are advocates of citizens rights and the rule of law. They oppose things like the arbitrary search and seizure of personal property by the police, the breaking up of demonstrations unfavorable to powerful people, etc. At it’s core is the right of personal property and freedom of speech. There is probably more here, but those are quite important. People make choices about how to live (and where to live!) based on them. That is why many choose to immigrate to the US, because those freedoms are protected here. They may change incrementally based on court decisions, new laws, but those are usually marginal changes.

The same concept applies to businesses. They operate in a given framework of taxation, private property, contract enforcement and competition. Changing the rules ex-post has massive effects on the US economy. If the Federal Government were to unilaterally seize BP’s assets, it would be catastrophic, akin to Obama having the leader of the Republican party jailed on treason charges. I don’t think I’m overstating this.

This is an extreme example, and honestly, I’m not that worried that any politician is taking this campaign seriously. But other smaller things may be tempting – like changing penalties and then making them retroactive. Even the $20B escrow account that the government has, ahem, “encouraged” BP to create is of dubious legality and still may be struck down by the courts. The fact is, Obama is in a tough position because he can’t just “kick BP’s ass.” BP has legal rights and is subject to the law, but no more. They will pay the fines and penalties based on current law, and laws will probably be enacted which apply to future spills, but not to BP.

We can’t punish them after the fact simply because we don’t like the outcome. To do so would create massive uncertainty in the business community – if a firm can be wantonly fined and/or taken over by the administration doesn’t like what it is doing is what Putin’s Russia is all about, not the United States. This will cause businesses to slow or stop investment and/or close and move abroad to an environment which is more predictable. Job losses follow and the economy falters further. People are understandably upset at what happened, but there are limits to what we can do – and that is a good thing.

a safer financial system?

Sam Peltzman is an economist who popularized what became known as the Peltzman Effect – that safety regulations (may) induce riskier behavior. The canonical example is in cars. He showed (Journal of Political Economy, 1975, “The Effects of Automobile Safety Regulaton”) that additional safety devices (regulated or voluntary – he focused on regulation) caused drivers to engage in riskier behavior. In specific, he showed that the number of non-fatal car crashed increased as did the number of pedestrian deaths due to car crashes.

Why does this happen? As with anything, there is a cost-benefit trade-off. The benefit to riskier (read: faster, more aggressive) driving is getting to your destination faster – most people view time as a valuable resource. The costs are somewhat obvious -  higher risk of accident. Specifically, there are the costs of personal injury to you, the driver, other passengers, and the cost of replacing your car. Of those, given car insurance, I think it is safe to say that the cost of personal and passenger injury is by far the major cost. With better crumple zones, airbags, and seatbelts, we have lowered the cost of an accident given that an accident happens. The problem is that by inducing riskier behavior, we increase the probability of an accident.

Here is a little math for the geeky probablists among us. Those who are math-phobic may want to skip this – it is intended to help people understand, not confuse. Let P(Injury | Accident) be the probability of Injury given an Accident. Let P(Accident) be the unconditional probability that an accident happens. Let’s ignore the cost of fixing your car or increased insurance payments, and let’s assume that the hospital bills and other personal costs (monetary or not) are constant. The, the probability that you are injured is P(Injury | Accident)*P(Accident). So, if additional safety features reduce P(Injury | Accident) then your cost has gone down. If your Overall Benefit = Benefit of Time Saved – Cost of Accident then you are better off! The problem is, accidents are rare, but you get benefits from time saved every time your drive. A whole bunch of small benefits (2-4 minutes?) of saving time is nice. So what do you do? You drive a bit faster, Overall Benefit stays the same because while you increase Benefit of Time Saved but you simultaneously increase Cost of Accident by increasing P(Accident).

Here is a personal experiment. If you are someone who typically drives with your seatbelt on (I do, I hope you do also), then experiment with driving without it for a while. I know I’ve occasionally skipped it for a quick trip to the store – or at least I started to; after a while, I felt a bit naked without it. As soon as I put it on, I felt more secure. That – that ‘secure’ feeling – is a little glimpse of what causes this problem. You feel more secure than you should. Gordon Tullock, another economist, has tongue-in-cheek proposed an “airbag” which is a 10″ spike that comes out of your steering column in the case of an accident. While nobody is proposing that in reality, it sure would make for safer drivers! By making P(Injury | Accident) = 1 (you face certain death in case of accident) you are fully incentivized to make P(Accident) as low as possible. And everyone is safer. That is because there are Externalities here as well: the pedestrians. They gain nothing from you driving faster, they only bear the cost of more reckless driving. So, we could say that increased automotive safety has increased the risk to pedestrians due to the externality. Safer drivers also mean safer pedestrians.

OK, that was sort of long. Why did I go through all of that? Because it relates to Financial Regulation. Do we want a “safer” financial system? I’m not sure we do. One of the things we found out for sure is that Wall Street bankers took enormous risks because they had at least the perception of safety. While some certainly may have knowingly sold dodgy securities, most of the purchasers (current Justice Department investigations nonwithstanding) were themselves sophisticated investors who should have known better. Everyone felt safe – markets were rising, business was good, no need to read all that fine print – look at how great this CDO has performed over the past 6 months! Investors bought all manner of securities they didn’t really understand because it seemed fine at the time; they also made a bit more money off of a AAA CDO than they did off of a AAA Government Bond. They take the small benefit now (saving a few minutes driving) while increasing the probability that something bad would happen – housing bubble and then collapse. Imagine each Wall Street bank as a bunch of drivers on the highway who, over time, find that they can drive faster and faster and closer and closer with quicker lane changes and fewer signals. There were a few bust ups along the way – Long Term Capital Management in 1998, and then a bit closer to home Bear Sterns collapse in March 2008. But each time, the creditors lost nothing – i.e the drivers got new cars. Until we had the Big One in Sept 2008 – a massive, multi-car pileup with injuries.

Our capitalist system requires that failure is an option. If it is not, all we can do is prepare for more and more risky behavior. If failure is not so bad, then why not take bigger and bigger gambles? Why did bank profits come right back; and at record levels? They got bailed out – and with fewer competitors to split the pie than before. We need a system that allows both success and failure. Right now, once big enough, that doesn’t apply any more; and I’m not sure it is limited to big banks. Passing legislation to make our financial system “safer” to me is the wrong direction. We need a system that is riskier, but at a smaller scale. We need a system with smaller banks, any of which can fail at any time.

However, I’m skeptical that this will happen. The current financial regulation bill about to be passed does nothing really, which is chronicled well at Baseline Scenario by Simon Johnson and James Kwak. I’m a bit afraid that we’re headed toward bigger business and bigger government, which to me simply says we’ll have fewer blowups, but they will be bigger in scale each time. I’d rather have more frequent, but smaller crises.

Excellent post on how Firms create value

From NYT Economix Blog.

Jonathan Chaplin on Loving Faithful Institutions

From The Other Journal at Mars Hill Graduate School. The whole piece is long, but well worth reading.

One illustration of this task, I’ve been suggesting, is to develop faith-guided models of normative business corporations (rather than just lambasting the shortcomings of existing ones). This won’t come easy. It will require a combination of extensive practical experience of the business world at many levels and extensive knowledge of the traditions of Christian-inspired social and economic reflection. Without the resources of business entrepreneurs, theologians, philosophers, or ethicists can fulminate against “oppressive global capitalism” until the cows come home (if you’ll now forgive a lapse into pre-industrial language), but Christian business practitioners will not give them the time of day. 

Yet without the resources of the traditions of Christian social thought, the result will be similar to what I have all too often encountered from business students at (even) Christian colleges. From their accounts, it becomes clear that their business professors often have neither the training nor the inclination to take any real critical distance from the reigning secular, utilitarian, liberal economic paradigms in their field. And the result of that deficiency is that generations of young Christian businesspeople will be sent out into the world of work thinking that the currently dominant structure of the business corporation is already normative from a Christian point of view. Some of these young businesspeople may turn out to be generous benefactors to Christian causes, but few will be transformers of the corporate sector in the direction of an economy of hope, justice, and solidarity.

The Collapse of Complex Business Models « Clay Shirky

In 1988, Joseph Tainter wrote a chilling book called The Collapse of Complex Societies. Tainter looked at several societies that gradually arrived at a level of remarkable sophistication then suddenly collapsed: the Romans, the Lowlands Maya, the inhabitants of Chaco canyon. Every one of those groups had rich traditions, complex social structures, advanced technology, but despite their sophistication, they collapsed, impoverishing and scattering their citizens and leaving little but future archeological sites as evidence of previous greatness. Tainter asked himself whether there was some explanation common to these sudden dissolutions.

The answer he arrived at was that they hadn’t collapsed despite their cultural sophistication, they’d collapsed because of it. Subject to violent compression, Tainter’s story goes like this: a group of people, through a combination of social organization and environmental luck, finds itself with a surplus of resources. Managing this surplus makes society more complex—agriculture rewards mathematical skill, granaries require new forms of construction, and so on.

Early on, the marginal value of this complexity is positive—each additional bit of complexity more than pays for itself in improved output—but over time, the law of diminishing returns reduces the marginal value, until it disappears completely. At this point, any additional complexity is pure cost.

Tainter’s thesis is that when society’s elite members add one layer of bureaucracy or demand one tribute too many, they end up extracting all the value from their environment it is possible to extract and then some.

The ‘and them some’ is what causes the trouble. Complex societies collapse because, when some stress comes, those societies have become too inflexible to respond. In retrospect, this can seem mystifying. Why didn’t these societies just re-tool in less complex ways? The answer Tainter gives is the simplest one: When societies fail to respond to reduced circumstances through orderly downsizing, it isn’t because they don’t want to, it’s because they can’t.

The Collapse of Complex Business Models « Clay Shirky.

HT: BoingBoing

Successes and Some Growing Pains at Hulu – NYTimes.com

My wife and I recently ditched cable entirely in favor of a combination of Netflix (even the $8.99 bottom-level subscription gets you unlimited access to their already pretty good and constantly growing instant-streaming catalog) and online video from sites like Hulu. We bought a $20 adapter for our laptop (a 3 year old Macbook Pro) and now pay $70 less a month.

We watch the ads on Hulu, as much as we did on cable or broadcast TV. I would consider paying some kind of subscription, if the deal was reasonable. There are lots of ways to make it more profitable, better for consumers, and used more. There are really only 2 things in the way, and neither of them are technological.

1. Corporate shortsightedness. Cable companies are (rightly) afraid that consumers will prefer something on-demand nature of web video rather than the firehose that is cable. They hobble burgeoning web video to protect what they perceive to be their own stable base of cable subscriptions. In this way, they are like the railroad companies who failed to perceive that they weren’t in the railroad business; they were in the transportation business. Media is headed to the internet, and companies that see sites like Hulu as their competition rather than their future will end up as feeble as the railroads.

2. Stigma against the Internet. Ads on broadcast television command far higher fees than internet ads. Some of this is understandable; many browsers have various ad-blocker extensions you can install, and of course television is a much older medium than the web. But I spend as much time online as I do watching television, if not more, and there’s no reason advertising on a TV show that “airs” over the internet has to be any different than one that’s broadcast in the traditional manner. In fact, the web can probably provide much more accurate metrics for advertisers than the highly questionable Neilsen ratings system.

Much like the anticipated demise of newspapers, the apparent threat that online video presents to established media companies is entirely a result of their misunderstanding their own business. They are entrenched in old business models where they control everything and the consumer passively watches the television they make. But they don’t make television; they make content. I want to watch that content, along with my own movies, and the stuff from YouTube or whatever, when and how I want. I’m willing to pay for it through subscriptions or by watching ads. The pipe on which that content rides to my house should be irrelevant to them. And if they can’t figure out how to make money at it, somebody else will.

Successes and Some Growing Pains at Hulu – NYTimes.com.