Wednesday, September 3, 2014

Framing is everything

Joe Stiglitz recently wrote this comment in his review of Martin Wolf’s ‘The Shifts and the Shocks’ (HT: EV):
"the problem is not an excess of savings but a financial system that is more fixated on speculation than on fulfilling its societal role of intermediation between those with excess funds and those who need more money, in which scarce savings are allocated to the investments of highest social returns."

It strikes me as an example of how our paradigms create predetermined narratives.  For instance, here we see the housing boom of the 2000's categorized as financial speculation.  This has become a common framing.  Yet, if in 1998, or even in 2002, you had polled people to describe what things would look like in the year 2005 in two scenarios - (1) an economy characterized by a speculative frenzy or (2) an economy characterized by high levels of low-risk savings - would anyone have answered that a speculative economy would be characterized by a sharp increase in home equity, low leverage among non-financial corporations, and strong long-term bond and commodity markets?

What we saw was an extreme example of low-risk, high savings behavior.  So, what did we do?  We simply re-interpreted low-risk, high savings behavior as speculative.  It was easy to do.  Extreme behavior in any direction will start to seem speculative.  As the demand for low-risk savings vehicles increases, the quality of the supply of low-risk savings vehicles will decline.  How can it be any other way?

And, of course, we see victims of the supposed reckless behavior in the high numbers of minority and working class homeowners who lost their homes.  This is in contrast to those halcyon days when bankers used to behave responsibly - when in demand crises, only wealthy homeowners defaulted, I guess.  And, thus, math and the inevitable biases of scarcity become servants of our paradigms.

Now, imagine how we would describe the past decade if private intermediaries had doubled their leverage in just a few years, with little change in production?  Talk about a speculative bubble!  Joe Stiglitz would be apoplectic.  Yet, this pretty much describes public finance since 2008.

I don't want this to be taken as a comment on the appropriate level of public debt, public budget deficits, etc.  My point is simply that narratives are largely pre-determined.  Many people see the private sector as a dangerous, anarchic mess of greedy private financial predators.  Even when firms and investors "hoard" cash, they are derided as greedy predators.  I doubt that there is any economic dislocation that wouldn't reflexively be blamed on greedy corporations and speculators.  On the other hand, is there any level of public financial activity that would lead to broad characterizations of speculation?  Public debt in Japan is now roughly where private debt was at the height of their speculative boom.  Do we frame Japan now as being in a speculative boom?

I don't mean to paint this as the entire story.  There is a lot going on here, and there are many details to consider in the full narrative, to say the least.  But, as a start, I think it is important to realize that the tendency to ascribe dislocations to greedy private financial interests is deep-seated, and generally is not a product of relative empirical trends.  We are born with a biological preference for political dispensation of bounty.  The insights of Adam Smith and of Charles Darwin are both discoveries of emergent order.  Groups of skeptics for each of these pioneers tend to be mutually exclusive, which is odd, because the skepticism arises from the same biological bias - we prefer that dispensations have been arranged by our tribal head, whether god or politician (frequently as a single entity identified as both).


  1. Excellent points Kevin. I think you should look to expand and develop that line of thinking there in that last paragraph. That line of reasoning related to hierarchical authority is an oft overlooked aspect of statism and leftism. They say don't they (it may be an urban myth) that when libertarians go to Singapore they hate the place, but when lefties go there they love it - and I think that has to do with the authority thing that leftists (secretly) crave despite the low tax free market stuff.
    Anyway, develop this - I think there's a lot for libertarians in evolutionary theory.

    1. Thanks, Sean. It's a recurring theme. If you read my blog, you'll probably get tired of hearing it eventually. There is a lot to think about in Robin Hanson's homo-hypocritus idea that probably explains a lot of the intractability of disagreements between libertarians and others.

    2. Let's see now, wasn't Stiglitz the coauthor, back in 2002, of a paper that claimed, "on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero."