The gathering storm

Public reactions to two recent news items trouble me greatly. A few years ago, people like myself wanted to buy a house but felt that prices were somewhat inflated and it'd be better judgment to rent rather than overstretch. Also, many people foresaw that trouble in the Middle East would have an impact on global markets, and bought shares in energy companies. Today we've learnt that both examples of successful entrepreneurial decision-making have been vindicated:

• UK house price fall 'at a record'
• Anger over £1bn Centrica profits

Obviously in the meantime many other judgments have proven incorrect, so I'm not trying to argue this from any particular side of the fence. The important point to realise is that when I put my savings into a low risk savings account, and when others put theirs into energy stocks, they were spending their own money. The incentives for thinking long and hard about what to do stemmed from the risk of losing some of that money should we get it wrong.

But note some of the reactions - which, I feel, receive broad public support:

• Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors (Rics), said that the focus should now be on kick-starting the mortgage market.
• After Centrica's results, a group of council leaders said energy suppliers should be subjected to a £500m annual charge to beat fuel poverty and cut carbon emissions.

Both of these points redistribute resources, penalising good judgment and subsidising poor judgment. The basis of a market economy is that people have the freedom to bet on ideas, and be responsible for the consequences of their action. Whereas in most walks of life we view mistakes as character building and a necessary part of development, the credit crunch is begetting the view that losses should be shared. Is anyone else concerned by the irony that current conditions are the consequence of not holding mortgage companies to account for risky lending? You don't reduce risk by redistributing resources. You reduce it by creating the incentives for sensible judgment.

Comments

[Jim]

Seems to me the credit crunch is a great example of people losing out through no fault of their own. Thousands of people have lost jobs in construction simply because banks have stopped lending to each other. That's got very little to do with poor judgement being punished.

[aje]

So why were those people working in construction?

[Jim]

All sorts of reasons. Have you got something in mind?

[aje]

I just don't see how any of those reasons wouldn't involve judgment, the issue is then whether it's poor judgment. You tell me me whether this is a unique and obscure position but I would contend that:
- Some of those construction workers are better off having enjoyed the boom than if it never happened
- The fact that it was a bubble made it difficult for people to exercise judgment, encouraging people to make poor decisions. This is the signal-extraction problem at the root of the Austrian business cycle theory - people are "fooled" because bubbles obfuscate market signals.
Therefore I don't think that it's "no fault of their own" since that would imply they're just automated agents that don't exercise choice (and therefore judgment), but it is a lot harder to judge things in a world of artificially low interest rates.

[Jim]

Well if your definition of 'poor judgement' encompasses not forseeing something that nobody foresaw, then sure, you're right. But that's a crazy definition. Look, if housebuilders were in trouble in the UK because they had gone on a huge building spree and over-supplied the market, that would be poor judgement. But instead they're in trouble because of a problem in the banking system which even those who work in the banking system didn't know about or didn't understand or were trying to cover up. Now if *in retrospect* that problem "made it difficult for people to exercise judgment" as you say I don't see how you then turn around and blame them for exercising what you now feel able to declare was bad judgement. If the troubles in UK construction are caused by a bubble in the US itself caused by artifically low interest rates (it's not at all clear that was the case in the UK where housing supply remained low and real interest rates were higher) then that makes culpability even more tenuous. If you want to fault the US government, go ahead and do so, but that means you can't pin the blame on individual poor judgement like you're trying to.

[aje]

Plenty of people foresaw it (e.g. ) and I know of city folk who've been preparing for a credit crunch for a long time. I don't see why it's a "crazy definition" of poor judgment to simply say that people have made mistakes. I don't mean "poor" as in "stupid", I mean it as in "ex-post incorrect".

I am *not* pinning the blame on individual poor judgment, I am merely maintaining that whenever anyone makes a decision about the future it involves judgment. By creating moral hazard these policies make bad judgment more likely. I assign blame to monetary authorities, not to construction workers. But rather than treat them as robots I want to know what caused them to make erroneous decisions.

I feel we're going round in circles. This argument is in papers forthcoming in QJAE and Economic Affairs, both of which are available for free. When they're out i'll post links.

[Jim]

Well, I don't think you 'foresaw' much at all. As you said, it didn't take much to see that house prices wouldn't keep rising, but your specific prediction was that "as soon as prices dip [homeowners will] put theirs up on the market to cash in, and in doing so produce a crash". But prices dipped in 2005 only to immediately start rising strongly again. And this time around sales have fallen off rather than increased.

On the more important point, if what you called 'poor judgement' is actually 'ex-post incorrect', I don't agree that people who are just found to be incorrect after the fact should necessarily be 'penalised' as you suggest, when the cause has more to do with bad luck than with bad judgement. I'm not suggesting the state should try and interfere in every case of bad luck - that's why we have welfare, though I wonder whether you view that as an unacceptable interference in market processes too.

[aje]

Exactly - I was too early. Some others are too late. It's difficult. But entrepreneurs aren't successful because of "luck", it's because they manage to anticipate the future better than others. There's a difference between exercising judgment under uncertainty and plain randomness.

I have nothing against voluntary welfare at all, and was bowled over by the amount of charitable giving and philanthropy when I lived in the US. The problem is providing insurance without creating moral hazard, and I feel that the policies i've mentioned cross that boundary. The bottom line though is that we don't all have to expose ourselves to risk. The people getting stung are real-estate speculators, if they chose to put their money into a low risk savings account they'd be alright. Fortunately we have entrepreneurs who are willing to expose themselves to risk on our behalf, and that's why they deserve their profits.

[Jim]

I'll skate over the issue of voluntary welfare and insurance issue, except to note that the former plainly can't provide the latter.

The people getting stung are real-estate speculators

No, there are plainly lots of other people getting stung too, basically as collateral damage. That's the point. You're arguing that a bricklayer who is laid off as a result of the credit crunch deserves what's coming to him because he didn't see it coming.

Fortunately we have entrepreneurs who are willing to expose themselves to risk on our behalf, and that's why they deserve their profits.

So a property owner 'deserves' every increase in the value of their property? Even if it comes as a direct result of state action?

[aje]

You're arguing that a bricklayer who is laid off as a result of the credit crunch deserves what's coming to him because he didn't see it coming.

No, i'm simply trying to understand what incentives led him to enter an industry that perhaps wasn't the best long term one to be in. It is because of my sympathy for the bricklayer that I want to understand more about how monetary policy disrupts market signals. But I am also concerned that the person who foresaw the credit crunch and didn't become a bricklayer, should be penalised.

So a property owner 'deserves' every increase in the value of their property? Even if it comes as a direct result of state action?

No. It's deserved if it's a result of entrepreneurial judgment. If it's a result of state action (e.g. an asset bubble) I have sympathy for them. But I don't think that slaves should compensate their owners.

[Jim]

The problem is that the results of entrepreneurial judgment are not separable from the results of state action - e.g. building a school nearby, or restricting supply, indeed property 'entrepreneurs' often find their success by their ability to spot or even influence such actions - or the results of the actions of other agents, eg 'desirables' or 'undesirables' moving into or out of an area affecting house prices. So I think returns from property are a very poor indicator of entrepreneurial skill, and a similar point applies to other fields, albeit perhaps to a lesser extent.

[aje]

the results of entrepreneurial judgment are not separable from the results of state action

Analytically, yes they are. Ordinarily this doesn't really matter. Person A might be wise to become a Health and Safety officer despite it being a subsidised profession, because they (probably correctly) realise that it is a long term role. Person B is less wise to go into construction because rather than be a long term subsidy a large amount of current conditions are short-term bubble activity that is liable to burst (and you might blame this on bankers, whilst I blame monetary authorities, but that's a separate discussion). I agree that the greater the degree of state involvement the more that rent-seeking becomes intertwined with entrepreneurial profits. If it's stable then it's an ideological choice for people to make - whether they want to draw their living from voluntary exchange of through taxation. But here we're talking about bubble activity. This isn't an ideological choice it's a scientific decision about the extent to which the industry is genuinely profitable (versus being propped up by easy money that is liable to be switched off). My concern stems from the fact that the man on the street is rationally ignorant of monetary theory, and therefore more prone to be fooled by mixed signals coming out of the Central Bank.

[Suban]

on junio 29, 2008 feliz cplmue cabezón!!!!!!! ya eres todo un viejo xDDDD!! te quiero mucho cuidate besos y a emborracharse!!! cya old man!!!! ***********

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