PART I
Standard economic theory tells us the the price of labor in a free market economy should be equal to its marginal product. The intuition behind it is as follows: let's say Firm A decides to keep wages lower then the value of the marginal product that results from that labor -- then Firm B can make money luring away workers from Firm A by paying a little more and reaping the benefit of the marginal product. That competitive process should continue until equality is reached.
That's the theory, what is the reality?
Let's say you look back historically and plot labor productivity (output per worker) vs. worker compensation. Economic theory suggests that over time, these should move in tandem. And in fact, in the US, from 1947-1982, that is exactly what one sees. If you graph it out (as can be found in the third chart here: http://economistsview.typepad.com/timduy/2012/04/distributional-impacts-of-monetary-policy.html) the two lines move together. But after 1982, the two lines diverge: labor productivity rockets up but worker compensation stagnates. Worker wages cease to reflect the productive value the workers provide and the gap has steadily increased over time. Put another way, while worker productivity in the US has almost doubled since 1973, real median wages over the same period increased only about 4%.
That's the problem - it has received extensive coverage and attention - the question is why?
I think this thread needs naked women.
Should labor productivity really drive the wages? Let's say I own a farm, and have 100 migrant workers (all of them legal, as far as other interested parties are concerned) collect the harvest. Then, one day, I take out a loan to buy a John Deere tractor, and hire one guy to operate it and do the job of the 100 legal migrant workers.
That one guy is 100 times as productive compared to migrant workers, but why should he be paid 100 times as much? If I pay him 100 times as much, then I'm worse off after buying the tractor, because now I have to find some additional money to pay for the interest on the loan that I took out to buy the tractor.
Quote from: Josephus on May 03, 2012, 12:32:31 PM
I think this thread needs naked women.
Maybe later.
But first, let's hear what Joan has to say. Some of us asked him for this.
DG is onto something here, I think. I seem to recall from my childhood that in the early to mid 80s automatization of production was a very hot topic in Germany (i.e. substituting labor with capital). This would have increased productivity enormously. With wages not increasing as much, production costs should go down, i.e. the goods can be brought to the market for cheaper (at least as far as labor is involved - not talking raw materials) - and they retain affordable for people whose income didn't go up as quickly as productivity.
Which could lead into a consumerist society which we of course don't have.
Or something. I'm not an economist. :P
Quote from: DGuller on May 03, 2012, 12:37:42 PM
Should labor productivity really drive the wages? Let's say I own a farm, and have 100 migrant workers (all of them legal, as far as other interested parties are concerned) collect the harvest. Then, one day, I take out a loan to buy a John Deere tractor, and hire one guy to operate it and do the job of the 100 legal migrant workers.
That one guy is 100 times as productive compared to migrant workers, but why should he be paid 100 times as much? If I pay him 100 times as much, then I'm worse off after buying the tractor, because now I have to find some additional money to pay for the interest on the loan that I took out to buy the tractor.
JR is talking about median wages of people that are employed. I dont think the figure takes into account the people that are not employed.
Second, the standard theory, as explained by JR, suggests that if you kept the sole remaining worker at the same salary a competitor would lure him away with slightly higher wages (there is a lot of room for an increase given the greater productivity) and you will be stuck with the tractor and no one to drive it and so you will also need to raise your wages accordingly until some kind of equilibrium is reached.
JR, awaiting party 2. :)
Quote from: DGuller on May 03, 2012, 12:37:42 PM
Should labor productivity really drive the wages? Let's say I own a farm, and have 100 migrant workers (all of them legal, as far as other interested parties are concerned) collect the harvest. Then, one day, I take out a loan to buy a John Deere tractor, and hire one guy to operate it and do the job of the 100 legal migrant workers.
That one guy is 100 times as productive compared to migrant workers, but why should he be paid 100 times as much? If I pay him 100 times as much, then I'm worse off after buying the tractor, because now I have to find some additional money to pay for the interest on the loan that I took out to buy the tractor.
If I buy the tractor, and the farmers around me buy the tractor, I'm going to think about slashing the wages of the guy I hire. After all, there are now 100 farm workers for every job.
Quote from: crazy canuck on May 03, 2012, 01:08:21 PM
JR is talking about median wages of people that are employed. I dont think the figure takes into account the people that are not employed.
Second, the standard theory, as explained by JR, suggests that if you kept the sole remaining worker at the same salary a competitor would lure him away with slightly higher wages (there is a lot of room for an increase given the greater productivity) and you will be stuck with the tractor and no one to drive it and so you will also need to raise your wages accordingly until some kind of equilibrium is reached.
JR, awaiting party 2. :)
Two things, as far as I can see. Let's assume that driving the tractor is not a rare skill, at least not to the extent that being able to bend forward and backwards for 12 hours a day without keeling over is. There are 99 of the former employees waiting to take the seat behind the tractor if the current guy is not happy.
But, let's assume that those 99 other guys eventually found other jobs, or that immigration police found them, so they're not desperately competing for the tractor job anymore. Let's also assume that competitors have tractors on their own. They still can't bid up the tractor driver's wage 100 times, because all of the farm owners have to spend capital to get the tractor, whereas they didn't have that capital outlay previously. Surely capital costs have to eat into some of that 100x productivity gain.
Quote from: alfred russel on May 03, 2012, 01:18:19 PM
Quote from: DGuller on May 03, 2012, 12:37:42 PM
Should labor productivity really drive the wages? Let's say I own a farm, and have 100 migrant workers (all of them legal, as far as other interested parties are concerned) collect the harvest. Then, one day, I take out a loan to buy a John Deere tractor, and hire one guy to operate it and do the job of the 100 legal migrant workers.
That one guy is 100 times as productive compared to migrant workers, but why should he be paid 100 times as much? If I pay him 100 times as much, then I'm worse off after buying the tractor, because now I have to find some additional money to pay for the interest on the loan that I took out to buy the tractor.
If I buy the tractor, and the farmers around me buy the tractor, I'm going to think about slashing the wages of the guy I hire. After all, there are now 100 farm workers for every job.
You are assuming that all 100 can drive the tractor.
We have been automating production since the early 19th century. Among the classical economists that looked into the question, some theorized exactly as DG and Syt have done in this thread - i.e that greater automation and use of capital in the production process would render workers redundant and hence lower wages and employment. The most rigorous defender of this position was Karl Marx. He used a modified Ricardian model to predict that wages would tend to fall to subsistence levels.
He was wrong.
To get an idea why he might have been wrong, think about what happens if Farmer A implements some efficiency creating technology - an E Machine - , so that now a single worker can produce 20 bushels a day instead of 10. Let's say A used to pay the worker a $1 per day so that before his labor cost was 10 cents a bushel and now it is 5 cents a bushel. If we assume there is free competition, then Capitalist A and his neighbor Capitalist B are price takers (i.e. they are too small in themselves to affect the price of wheat). Capitalist B now sees an opportunity - he can hire away A's worker and pay up to $2 a day and produce more bushels and make more money. Competition forces up the wage.
The objection to the story is that if everyone does this, production will increase so much that it will bring down the price of wheat and thus the marginal revenue product of labor from the farmer's perspective. In addition, depending on the price elasticities this means that production will not increase as much is technologically feasible, which means that fewer workers will be demanded than before. This objection holds but there is a big counterveiling force that also must be taken into account. As a result of the E Machine, fewer farm workers are now needed to farm wheat, but more workers are now required to design, build, market and transport E Machines. Also since the Farmer-Capitalists are making more money, they will do things like re-paint their barns and buy something nice for the wife and maybe a sports car for thenselves. The E-Machine workers and inventors will do similar things and so on. This all creates demand for more commodities and the labor to produce them and that demand then produces more spin-off demand and so on.
But how do we know whether these counterveiling considerations will fully compensate for the impact of higher wheat productivity. The short answer is that Say's Law says that it will. But does Say's Law actually hold? JS Mill answered that question over 150 years ago. It does hold, tautologically in fact, but only on the assumption that there are no financial assets.
That last bit gives a hint of where problems may arise . . .
Put your dick on the table already. Enough stalling.
Quote from: DGuller on May 03, 2012, 01:31:27 PM
Quote from: crazy canuck on May 03, 2012, 01:08:21 PM
JR is talking about median wages of people that are employed. I dont think the figure takes into account the people that are not employed.
Second, the standard theory, as explained by JR, suggests that if you kept the sole remaining worker at the same salary a competitor would lure him away with slightly higher wages (there is a lot of room for an increase given the greater productivity) and you will be stuck with the tractor and no one to drive it and so you will also need to raise your wages accordingly until some kind of equilibrium is reached.
JR, awaiting party 2. :)
Two things, as far as I can see. Let's assume that driving the tractor is not a rare skill, at least not to the extent that being able to bend forward and backwards for 12 hours a day without keeling over is. There are 99 of the former employees waiting to take the seat behind the tractor if the current guy is not happy.
Bad assumption. I cant think of a period of technological advancement where all employees could do the new job. One industry I know about that was impacted directly by technological advancement was the lumber industry here. When the mills invested heavily in robotics and computerization the unions went crazy over the fact that many of their older members (who remained employed because they has seniority) could no longer do their jobs because they didnt understand the new tech. Some went for retraining and picked it up but others simply took retirement packages and the newer "tech knowledgable" employees took their place.
QuoteBut, let's assume that those 99 other guys eventually found other jobs, or that immigration police found them, so they're not desperately competing for the tractor job anymore. Let's also assume that competitors have tractors on their own. They still can't bid up the tractor driver's wage 100 times, because all of the farm owners have to spend capital to get the tractor, whereas they didn't have that capital outlay previously. Surely capital costs have to eat into some of that 100x productivity gain.
Sure, its not a perfect correlation. I dont think JR is arguing for that. The problem is that two trend lines have in a sense de-coupled.
Quote from: The Minsky Moment on May 03, 2012, 01:40:15 PM
The objection to the story is that if everyone does this, production will increase so much that it will bring down the price of wheat and thus the marginal revenue product of labor from the farmer's perspective.
My objection is that higher capital costs are ignored in the calculation, or at least are not shown to be irrelevant. Now that you have an E Machine, you've got to take care of both capital and wage costs, where as previously you only had wage costs. The labor cost of the bushel may have gone down from 10 cents to 5 cents, but the capital cost of the bushel had to have gone up by x cents, where x > 0.
I was always under the impression that the divergence between productivity and compensation was explained by exactly the factor that DG brought up: that productivity is increasingly a product of investment in workers and in capital improvements, rather than labor investments per se. Someone can't hire away DG's tractor operator without buying a tractor, so DG only has to pay his tractor driver enough wages to keep competitors from hiring him away, not enough to make his wage increase equal to his productivity increase.
I'm not sure the "traditional theory" I "think I remember" necessarily accounts for the timing of the divergence in compensation versus output, though. It's been a long time since i have seen anything on the topic, and I could be misremembering.
Could the collapse of organized labour as a meaningful force be a factor? The timeline seems to fit.
Quote from: Neil on May 03, 2012, 01:50:48 PM
Could the collapse of organized labour as a meaningful force be a factor? The timeline seems to fit.
I'd think it was a consequence, not a cause, but I could be wrong.
Quote from: DGuller on May 03, 2012, 01:47:04 PM
My objection is that higher capital costs are ignored in the calculation, or at least are not shown to be irrelevant. Now that you have an E Machine, you've got to take care of both capital and wage costs, where as previously you only had wage costs. The labor cost of the bushel may have gone down from 10 cents to 5 cents, but the capital cost of the bushel had to have gone up by x cents, where x > 0.
Sure it's a cost, but it's not ignored. The machine isn't used unless net it is profitable. And to the exent the costs decrease the Farmer-Capitalist returns, they are increasing those of the E-Machine producers and workers.
Quote from: The Minsky Moment on May 03, 2012, 01:52:13 PM
Quote from: DGuller on May 03, 2012, 01:47:04 PM
My objection is that higher capital costs are ignored in the calculation, or at least are not shown to be irrelevant. Now that you have an E Machine, you've got to take care of both capital and wage costs, where as previously you only had wage costs. The labor cost of the bushel may have gone down from 10 cents to 5 cents, but the capital cost of the bushel had to have gone up by x cents, where x > 0.
Sure it's a cost, but it's not ignored. The machine isn't used unless net it is profitable. And to the exent the costs decrease the Farmer-Capitalist returns, they are increasing those of the E-Machine producers and workers.
Yes, but not linearly, which is the trend that was assumed to be normal. If I replace 5 cents of labor costs with 4 cents of capital costs, then I can only bid up the wages by 20% to $1.20 and not $2 (assuming the same margin), whereas BLS statistics would show 100% productivity improvement. Maybe it doesn't explain why this 20% is about 0% in practice, but it explains a great deal why it's not 100%.
Quote from: grumbler on May 03, 2012, 01:51:33 PM
Quote from: Neil on May 03, 2012, 01:50:48 PM
Could the collapse of organized labour as a meaningful force be a factor? The timeline seems to fit.
I'd think it was a consequence, not a cause, but I could be wrong.
I agree, I think it was a consquence of workers moving away from jobs that were traditional trade union jobs into areas unions were less successful in organizing - ie higher skilled positions created by technological advancements.
Quote from: grumbler on May 03, 2012, 01:48:33 PM
I was always under the impression that the divergence between productivity and compensation was explained by exactly the factor that DG brought up: that productivity is increasingly a product of investment in workers and in capital improvements, rather than labor investments per se.
If that were so, then divergence should have been constantly incresing since the Industrial Revolution, which clear is not so. That is the Marx thesis.
Another way to think about it is to apply to the facts re divergence in my first post. In the theory is true, then it most be true that investment in worker human capital, physical capital and technological efficiencies must have been far greater in the period after around 1980 (when divergence occurred) then the period rom 1947-1982. Indeed, since no divergence occurred in 1947-1982, one would expect to see stagnation in investment in human and physical capital and technology. But that is not a very plausible claim to put it lightly. That time period saw probably the two most efficiency-driving inventions of the century: containerization and the Green Revolution. It also saw the GI Bill and huge increases in the proportion of workers receiving higher education. In terms of physical capital investment, it is roughly equal throughout both periods.
Quote from: DGuller on May 03, 2012, 01:56:14 PM
Quote from: The Minsky Moment on May 03, 2012, 01:52:13 PM
Quote from: DGuller on May 03, 2012, 01:47:04 PM
My objection is that higher capital costs are ignored in the calculation, or at least are not shown to be irrelevant. Now that you have an E Machine, you've got to take care of both capital and wage costs, where as previously you only had wage costs. The labor cost of the bushel may have gone down from 10 cents to 5 cents, but the capital cost of the bushel had to have gone up by x cents, where x > 0.
Sure it's a cost, but it's not ignored. The machine isn't used unless net it is profitable. And to the exent the costs decrease the Farmer-Capitalist returns, they are increasing those of the E-Machine producers and workers.
Yes, but not linearly, which is the trend that was assumed to be normal. If I replace 5 cents of labor costs with 4 cents of capital costs, then I can only bid up the wages by 20% to $1.20 and not $2 (assuming the same margin), whereas BLS statistics would show 100% productivity improvement. Maybe it doesn't explain why this 20% is about 0% in practice, but it explains a great deal why it's not 100%.
Actually, speaking of the median wage growth being about 0%, is median even a good statistic in that sense? Median growth would be appropriate to analyze if the distribution of wages didn't change. In that case, you want to use the median, because average can be distorted by really high values. But, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
Quote from: The Minsky Moment on May 03, 2012, 02:03:28 PM
Quote from: grumbler on May 03, 2012, 01:48:33 PM
I was always under the impression that the divergence between productivity and compensation was explained by exactly the factor that DG brought up: that productivity is increasingly a product of investment in workers and in capital improvements, rather than labor investments per se.
If that were so, then divergence should have been constantly incresing since the Industrial Revolution, which clear is not so. That is the Marx thesis.
Another way to think about it is to apply to the facts re divergence in my first post. In the theory is true, then it most be true that investment in worker human capital, physical capital and technological efficiencies must have been far greater in the period after around 1980 (when divergence occurred) then the period rom 1947-1982. Indeed, since no divergence occurred in 1947-1982, one would expect to see stagnation in investment in human and physical capital and technology. But that is not a very plausible claim to put it lightly. That time period saw probably the two most efficiency-driving inventions of the century: containerization and the Green Revolution. It also saw the GI Bill and huge increases in the proportion of workers receiving higher education. In terms of physical capital investment, it is roughly equal throughout both periods.
I guess there are also multiple types of productivity gains. Some gains of efficiency are just free lunch, such as those that come from scientific breakthroughs or just plain genius ideas that no one thought of before. Other gains of efficiency are achieved only if you sink a lot of capital to get them. I imagine that those two kinds of productivity gains have different implications.
Quote from: Neil on May 03, 2012, 01:50:48 PM
Could the collapse of organized labour as a meaningful force be a factor? The timeline seems to fit.
That'd be one of my guesses, but I don't think it explains everything.
Interesting thread.
Quote from: DGuller on May 03, 2012, 02:06:35 PMBut, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
That would've been my other guess.
Quote from: DGuller on May 03, 2012, 02:06:35 PM
Actually, speaking of the median wage growth being about 0%, is median even a good statistic in that sense? Median growth would be appropriate to analyze if the distribution of wages didn't change. In that case, you want to use the median, because average can be distorted by really high values. But, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
You are on to something here. There is a divergence between median and mean compensation. As it turns out, that divergence accounts for over 40% of the divergence of the observed divergence between median wage growth and productivity since 1973. What is being captured here is increasing inequality in income. What it doesn't tell us is why or how it is happening. Why do these fat cats suddently spring up in the early 80s and why do they keep getting fatter? And why are the thin cats failing to pick up any scraps?
Quote from: The Minsky Moment on May 03, 2012, 02:17:03 PM
Quote from: DGuller on May 03, 2012, 02:06:35 PM
Actually, speaking of the median wage growth being about 0%, is median even a good statistic in that sense? Median growth would be appropriate to analyze if the distribution of wages didn't change. In that case, you want to use the median, because average can be distorted by really high values. But, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
You are on to something here. There is a divergence between median and mean compensation. As it turns out, that divergence accounts for over 40% of the divergence of the observed divergence between median wage growth and productivity since 1973. What is being captured here is increasing inequality in income. What it doesn't tell us is why or how it is happening. Why do these fat cats suddently spring up in the early 80s and why do they keep getting fatter? And why are the thin cats failing to pick up any scraps?
One reason could be that financial deregulation increased the ability of the financier fat cats to actually add value, which increased both their numbers and their value add, which in turn bid up their wages. EDIT: IIRC, productivity growth rate itself increased at about the same time as median wages decoupled from productivity growth, so maybe the fat cats were both the main drivers and the main beneficiaries of that trend.
To be clear, for this exercise I am essentially taking as a starting point that the neo-classical axioms hold and neo-classical theory holds, so that there is perfect competition, rational agents, etc. and Say's Law strictly holds. The next step is to allow relaxation of those assumptions but specify the conditions that an alternative theory must satisfy - namely that it must explain in the US context why no divergence occurs from 1947-1982 but then big and increasing divergence occurs afterwards.
Quote from: The Minsky Moment on May 03, 2012, 02:17:03 PM
Quote from: DGuller on May 03, 2012, 02:06:35 PM
Actually, speaking of the median wage growth being about 0%, is median even a good statistic in that sense? Median growth would be appropriate to analyze if the distribution of wages didn't change. In that case, you want to use the median, because average can be distorted by really high values. But, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
You are on to something here. There is a divergence between median and mean compensation. As it turns out, that divergence accounts for over 40% of the divergence of the observed divergence between median wage growth and productivity since 1973. What is being captured here is increasing inequality in income. What it doesn't tell us is why or how it is happening. Why do these fat cats suddently spring up in the early 80s and why do they keep getting fatter? And why are the thin cats failing to pick up any scraps?
Wouldn't automatization be the explanation here too? You need a smaller cadre of highly skilled workers - everyone else is unskilled labour. This explains inequality.
Notice that this phenomenon is not just limited to industry - "soft" businesses, like law, experience this too. Compare the efficiencies of running a law firm with e-mail available, and only with courier/fax. We are now outsourcing stuff like due diligence reviews to Delhi - this means we will still need less highly skilled, highly paid lawyers in future.
We are reaching a paradoxical society where the rich elite is actually working for the poor masses - and the redistribution is the only thing keeping them from raising in a revolt.
And we were doing so well.
Quote from: Martinus on May 03, 2012, 02:22:50 PMWe are reaching a paradoxical society where the rich elite is actually working for the poor masses - and the redistribution is the only thing keeping them from raising in a revolt.
Whereas you are revolting already.
Quote from: crazy canuck on May 03, 2012, 02:24:06 PM
And we were doing so well.
Now can we have naked ladies?
Quote from: Josephus on May 03, 2012, 02:28:06 PM
Quote from: crazy canuck on May 03, 2012, 02:24:06 PM
And we were doing so well.
Now can we have naked ladies?
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
Damn it, I have to study now. :mad: :( This discussion is way more fun, though.
Quote from: Jacob on May 03, 2012, 02:27:47 PM
Quote from: Martinus on May 03, 2012, 02:22:50 PMWe are reaching a paradoxical society where the rich elite is actually working for the poor masses - and the redistribution is the only thing keeping them from raising in a revolt.
Whereas you are revolting already.
:lmfao:
Quote from: crazy canuck on May 03, 2012, 02:30:44 PM
Quote from: Josephus on May 03, 2012, 02:28:06 PM
Quote from: crazy canuck on May 03, 2012, 02:24:06 PM
And we were doing so well.
Now can we have naked ladies?
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
The Man ™
Quote from: crazy canuck on May 03, 2012, 02:30:44 PM
Quote from: Josephus on May 03, 2012, 02:28:06 PM
Quote from: crazy canuck on May 03, 2012, 02:24:06 PM
And we were doing so well.
Now can we have naked ladies?
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
http://www.counterpunch.org/2008/01/10/three-big-reasons-for-the-decline-of-labor-unions/
1. The hollowing-out of the country's manufacturing base and, with it, a decline in those industry jobs which, historically, had not only been strongly organized but well paid.
2. Government has assumed custody of key union provisions.
3. Changes in demographics and culture.
Quote from: crazy canuck on May 03, 2012, 02:24:06 PM
And we were doing so well.
Well, "automation", being a cause for trends starting int he early 1980's makes sense in Poland not so much in the US.
PART II
The short answer is: I don't know and neither does anyone else.
The question can't be answered because there is no way to design an replicable experiment to test it. All one can do is try to identify factors that correlate with the data. But correlation is not causation - for example, one could probably easily show over the past 30 years in the US a clear inverse correlation between cigarette smoking and inequality of income but it is unlikely this is a causal relationship.
One thing we can do is use the absence of correlation to reject alternative hypotheses. For example, the automization hypothesis - this may correlate with the post 1982 experience but it falls down when applies to the pre-1982 experience. It jsut doesn't fits the facts and so it must be rejected. Similarly, the rise of Chinese competition doesn't work because China did not have significant impact on the world economy until the mid-1990s but this trend dates back over a decade earlier. The shift from manufacturing to services long predates the early 80s; that doesn't work either.
The best one can do is try to marry some correlative factor to some plausible theory explaining why that factor might logically give rise to the results. And as it turns out, someone in the thread (not me) has already hit on something that might work.
Quote from: crazy canuck on May 03, 2012, 02:30:44 PM
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
I think that public sector unions had something to do with it. When public sector unions would go on strike, they weren't sticking it to the man. They were sticking it to us.
Quote from: Neil on May 03, 2012, 02:44:55 PM
Quote from: crazy canuck on May 03, 2012, 02:30:44 PM
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
I think that public sector unions had something to do with it. When public sector unions would go on strike, they weren't sticking it to the man. They were sticking it to us.
That does not explain why people stopped joining unions so they could stick it to the man.
I think Josephus is on to a better answer. But I am wondering about his third point.
Quote from: The Minsky Moment on May 03, 2012, 02:44:32 PM
PART II
The short answer is: I don't know and neither does anyone else.
You are worse than a lap dancer performing on Malthus in front of all his friends.
Also, thanks very much for the thread.
Quote from: The Minsky Moment on May 03, 2012, 02:44:32 PM
PART II
The short answer is: I don't know and neither does anyone else.
The question can't be answered because there is no way to design an replicable experiment to test it. All one can do is try to identify factors that correlate with the data. But correlation is not causation - for example, one could probably easily show over the past 30 years in the US a clear inverse correlation between cigarette smoking and inequality of income but it is unlikely this is a causal relationship.
One thing we can do is use the absence of correlation to reject alternative hypotheses. For example, the automization hypothesis - this may correlate with the post 1982 experience but it falls down when applies to the pre-1982 experience. It jsut doesn't fits the facts and so it must be rejected. Similarly, the rise of Chinese competition doesn't work because China did not have significant impact on the world economy until the mid-1990s but this trend dates back over a decade earlier. The shift from manufacturing to services long predates the early 80s; that doesn't work either.
The best one can do is try to marry some correlative factor to some plausible theory explaining why that factor might logically give rise to the results. And as it turns out, someone in the thread (not me) has already hit on something that might work.
:rolleyes: :rolleyes: :rolleyes:
I want to know what Yi says.
I think trade unions declined in the Western world because they did not quite catch the fact that the nature of the "proletariat" has changed. It's not factory workers and the like anymore - most of them have been fired and those who stayed have a relatively good fare, being usually qualified employees.
The real "exploited masses" are now in service/retail industries and low level white collar jobs. And with the exception of some of the bigger chains, employers of these people usually do not employ enough workers for the workers to form influential trade unions.
The increasingly large role of computers in business and society seems to really get rolling around 1982 might that be connected?
Quote from: Martinus on May 03, 2012, 03:01:32 PM
I think trade unions declined in the Western world because they did not quite catch the fact that the nature of the "proletariat" has changed. It's not factory workers and the like anymore - most of them have been fired and those who stayed have a relatively good fare, being usually qualified employees.
You think that labour leaders didnt notice that the workplace was changing?
Quote from: Valmy on May 03, 2012, 03:04:42 PM
The increasingly large role of computers in business and society seems to really get rolling around 1982 might that be connected?
Minsky rejected this in my hypothesis, saying it happened before that.
:rolleyes: Now you find yourself in '82. What's next?
Quote from: The Minsky Moment on May 03, 2012, 02:17:03 PM
Quote from: DGuller on May 03, 2012, 02:06:35 PM
Actually, speaking of the median wage growth being about 0%, is median even a good statistic in that sense? Median growth would be appropriate to analyze if the distribution of wages didn't change. In that case, you want to use the median, because average can be distorted by really high values. But, if the distribution of wages does change, which is kinda tautologically true given the thread title, wouldn't median growth be misleading? Maybe that $0.20 per bushel that you saved with the E Machine now went to the newly created fat cat position of CFO to oversee the capital spending on the tractor, whereas previously you didn't need a CFO as you didn't have a lot of capital costs. That fat cat's salary growth would barely be reflected in the median measure.
You are on to something here. There is a divergence between median and mean compensation. As it turns out, that divergence accounts for over 40% of the divergence of the observed divergence between median wage growth and productivity since 1973. What is being captured here is increasing inequality in income. What it doesn't tell us is why or how it is happening. Why do these fat cats suddently spring up in the early 80s and why do they keep getting fatter? And why are the thin cats failing to pick up any scraps?
Politics and political influence peddling are two factors that cannot adequately been shoehorned into an economic theory.
Quote from: crazy canuck on May 03, 2012, 03:05:23 PM
Quote from: Martinus on May 03, 2012, 03:01:32 PM
I think trade unions declined in the Western world because they did not quite catch the fact that the nature of the "proletariat" has changed. It's not factory workers and the like anymore - most of them have been fired and those who stayed have a relatively good fare, being usually qualified employees.
You think that labour leaders didnt notice that the workplace was changing?
I think the #2 factor Josephus posted is the biggest one. Back then, the utility provided by the union to the average worker was much more valuable than it is now. The law protects the workers now, where unions had to step in on their behalf before. So the cost/benefit of joining and paying the dues is diminished.
I think it has less to do with manufacturing. Service jobs have unions too, after all.
Quote from: Martinus on May 03, 2012, 03:06:13 PM
Minsky rejected this in my hypothesis, saying it happened before that.
If you say so. I would be interested to see if there is a correlation. I mean PCs literally came on the market just a few years before that. I am not sure if they were as economical and as widespread before that that we can so cavalierly discard it as a possible culprit.
Also you said automization which is not exactly the same thing as personal computers.
Quote from: MadImmortalMan on May 03, 2012, 03:22:42 PM
Quote from: crazy canuck on May 03, 2012, 03:05:23 PM
Quote from: Martinus on May 03, 2012, 03:01:32 PM
I think trade unions declined in the Western world because they did not quite catch the fact that the nature of the "proletariat" has changed. It's not factory workers and the like anymore - most of them have been fired and those who stayed have a relatively good fare, being usually qualified employees.
You think that labour leaders didnt notice that the workplace was changing?
I think the #2 factor Josephus posted is the biggest one. Back then, the utility provided by the union to the average worker was much more valuable than it is now. The law protects the workers now, where unions had to step in on their behalf before. So the cost/benefit of joining and paying the dues is diminished.
I think it has less to do with manufacturing. Service jobs have unions too, after all.
I am not sure about that. There is a lot of research to suggest the main reason employees certify is not necessarily for economic protection (which government regulation is mainly directed at) but because they have an ass as a manager and the employer has no effective means for employees to bring grievances regarding their manager to a more senior level for consideration.
If you look at the companies that have been able to avoid unionization you will see many of them (with the exception of companies that employ other methods....) have put systems in place to address this issue.
No government regulation can help with that.
I'd expect that it's connected to the phenomenal rise in executive compensation and changes in the stock market and financial world that shifts focus on quarterly earnings and stock value over all else.
Basically, increased productivity gains went to feed the demands of Wall Street which, combined changes in regulation, meant that there was no excess capital to compete for workers - it all went to share prices. The survival and strengthening of a company was further removed from production basics; the gains there were dwarfed by the gains realized from riding the market correctly so all excess resources rationally went there?
... I don't know... something like that?
Aliens?
Quote from: Neil on May 03, 2012, 02:44:55 PM
Quote from: crazy canuck on May 03, 2012, 02:30:44 PM
Later.
But for now - to go off topic a bit. Why do you think the trade union movement declined?
I think that public sector unions had something to do with it. When public sector unions would go on strike, they weren't sticking it to the man. They were sticking it to us.
I think there's a lot of truth to that. And with public sector unions, I also include BIG unions. Like the auto union.
edit: And by this, it goes back to #3, cultural and demographic shifts. I think these unions, the big ones and the public sector ones, alienated non-union workers from the whole notion of unions. When a Toronto Transit Commission, coin collector was found to be making over 100 grand with overtime, the common man was like..WTF? Unions are overblown.
People no longer see unions as protecting the little guy, but rather, enriching the over-paid, no-skilled worker.
Quote from: The Brain on May 03, 2012, 03:13:09 PM
:rolleyes: Now you find yourself in '82. What's next?
The disco hotspots hold no charm for you.
Quote from: Josephus on May 03, 2012, 03:59:24 PM
Quote from: The Brain on May 03, 2012, 03:13:09 PM
:rolleyes: Now you find yourself in '82. What's next?
The disco hotspots hold no charm for you.
I have NO IDEA what you're talking about.
Quote from: The Brain on May 03, 2012, 04:02:05 PM
Quote from: Josephus on May 03, 2012, 03:59:24 PM
Quote from: The Brain on May 03, 2012, 03:13:09 PM
:rolleyes: Now you find yourself in '82. What's next?
The disco hotspots hold no charm for you.
I have NO IDEA what you're talking about.
That wouldn't be the first time.
But, in this case, you're either kidding, or too young to remember this classic 82 song:
http://youtu.be/keiMqTdvogo
Kid-ding? :unsure:
Quote from: The Brain on May 03, 2012, 02:53:58 PM
I want to know what Yi says.
The same thing but using much fewer words.
Quote from: Valmy on May 03, 2012, 03:04:42 PM
The increasingly large role of computers in business and society seems to really get rolling around 1982 might that be connected?
Computer use in business was well under way in the 60s and 70s. That is where one would expect to see the most immediate productivity impact.
The widespread use of computers for leisure and personal communication didn't really hit its stride until the AOL/Netscape era, which somewhat postdates our phenomenon. And the explanatory linkage between the two is hard to see.
Quote from: Jacob on May 03, 2012, 03:45:36 PM
I'd expect that it's connected to the phenomenal rise in executive compensation and changes in the stock market and financial world that shifts focus on quarterly earnings and stock value over all else.
Basically, increased productivity gains went to feed the demands of Wall Street which, combined changes in regulation, meant that there was no excess capital to compete for workers - it all went to share prices. The survival and strengthening of a company was further removed from production basics; the gains there were dwarfed by the gains realized from riding the market correctly so all excess resources rationally went there?
... I don't know... something like that?
If all the money went to share prices then the companies would be awash in capital with which companies could compete on wages. All that money didnt go to executive salary or dividends, although some did.
Also, the "it all went to" invites the question where did all that money come from? The profits realized by the companies who had the productivity gains? If so then your thesis would have to be that there was a vast amount of stock repurchasing going on with all that new found wealth. And while some of that did take place to some extent such activity did not reduce corporate capital to the point that those corporations could not afford to pay higher wages. Rather the reverse.
But I think you are on to something when you imply the need to maximize shareholder value. Which kind of brings back to the Guardian article and the question you asked JR - which JR still needs to answer...
Quote from: The Minsky Moment on May 03, 2012, 04:29:46 PM
Computer use in business was well under way in the 60s and 70s.
Maybe, but back then computer use was highly inefficient - punch cards used to program etc and even then they were used by a small minority. It was not until the 80s that they started to be used widely by business.
V may be on to something.
Quote from: The Minsky Moment on May 03, 2012, 02:03:28 PM
If that were so, then divergence should have been constantly incresing since the Industrial Revolution, which clear is not so. That is the Marx thesis.
Another way to think about it is to apply to the facts re divergence in my first post. In the theory is true, then it most be true that investment in worker human capital, physical capital and technological efficiencies must have been far greater in the period after around 1980 (when divergence occurred) then the period rom 1947-1982. Indeed, since no divergence occurred in 1947-1982, one would expect to see stagnation in investment in human and physical capital and technology. But that is not a very plausible claim to put it lightly. That time period saw probably the two most efficiency-driving inventions of the century: containerization and the Green Revolution. It also saw the GI Bill and huge increases in the proportion of workers receiving higher education. In terms of physical capital investment, it is roughly equal throughout both periods.
I've only read this far; sorry if I'm repeating.
The big change your missing is globalization. The supply of labor is determined globally, not domestically.
PART III
The question is what happened in the late 70s and early 80s and continued on later that was categorically different from what came before and can plausibly be connected to a significant effect on the economy. The biggest one I can think of was identified by DG and Jacob: the transformation of the financial sector through de-regulation and innovation and an accompanying explosion in the creation, retention and trading of financial assets, both old and new. Back in the early 70s, the financial sector was categorically different than today. Interest on bank deposits was controlled and regulated, as was broker commissions. Purchasing securities meant going through a full-service brokerage and paying hefty commissions. The high yield debt market was a despised backwater. Securitization was in its infancy. The banking business was heavily regulated and segmented by product, by charter type and by geography. Commodity futures were traded in relatively small volumes on a trading floor in Chicago. Options trading was small potatoes.
The world in 1975 or so looked pretty much like the financial world that existed 25 years earlier. But 25 years late it was unreognizable. In terms of new and more complex financial products, unprecendented de-regulation, and staggering increases in trading activity. New categories of instruments become trillion dollar markets. Trading in futures, options and foreign exchange increased by multiples in the hundreds. The regulatory changes and increases in trading activity in innovation started in the late 70s, gathered steam in the 80s and really took off in the noughties, and haven't looked back other than a brief hiccup in 01 and a bigger one in 08-09. It fits our timeline quite nicely, if one gives a couple years for the initial efforts to impact the broader economy.
The trickier part is coming up with the explanatory theory that ties this to the divergence. Not sure if i have a ckear answer but I'll take a crack my next opportunity.
Quote from: Admiral Yi on May 03, 2012, 05:49:40 PM
The big change your missing is globalization.
What makes the late 70s/early 80s the key turning point of globalization?
Why wouldn't impacts be felt in the prior period which saw extensive waves of trade liberalization, grwoth in cross-border investment and labor movement, the creation of a new international monetary system and international development banks ,and the development of the physical and legal infrastructure for international commerce?
Quote from: The Minsky Moment on May 03, 2012, 06:07:51 PM
What makes the late 70s/early 80s the key turning point of globalization?
Why wouldn't impacts be felt in the prior period which saw extensive waves of trade liberalization, grwoth in cross-border investment and labor movement, the creation of a new international monetary system and international development banks ,and the development of the physical and legal infrastructure for international commerce?
As you yourself say, the earliest GATT rounds dealt only with trade liberalization. The one necessary precondition for globalization was liberalization of capital markets. And I may be wrong, but I think that particular round of GATT coincides more or less with the opening of China, and both coincide more or less with the time frame you're focusing on.
Do reliable productivity and wage statistics exist for other countries? My first instinct would be to look at the trends in other countries, look for equivalent transformations or lack of them are are hypothesized to cause this decoupling pattern, and see if that relationship holds. Of course, there are multiple dangers with that approach, the main one being that other countries may have their own unique things going on that we might be at best vaguely aware of.
Ending Bretton Woods made it possible to have growth not shackled to gold? Maybe that's a bit early, but 82ish is really the first recovery since then.
This is anecdotal, and thus probably a weak way to enter this thread, but a few years ago I had a chance to tour the state of the art containerboard plant in the US (containerboard is basically reinforced paper products).
This plant was producing something like 7 tons of containerboard a day. The facility was the size of several football fields, and had trainloads of raw materials coming in regularly. It was a 24 x 7 operation. What was so striking is they had roughly 50 people at the facility, and half of those were finance, accounting, procurement, etc. in a side building. On the floor at any one time were usually just 3-4 people. Everything was automated--the non administrative people working were mostly engineers watching monitors off the floor.
Unionization at this plant was irrelevant--blue collar workers basically were completely replaced by automation: engineers and IT professionals.
This is a part of the manufacturing industry that is difficult to outsource. If blue collar workers are getting pushed out in this industry as well, it may show why they are falling behind right now, but that isn't really the question of the thread, which is why is 1% pulling away from 99%, not why are the 20% or so pulling away from everyone else (even if they are, at a slower pace).
I think some of the answer is in this plant as well. The paper products industry has historically had many plants in the country owned my many companies. Highly efficient plants like the one I visited mean we need less plants. Even sharper than the reduction in the number of plants is the reduction in the number of companies. I'll touch on this in the next post.
JR and others think about the changes in finance from a top down point of view: starting with the regulatory and trade environment. But I think a lot of the drivers are technological.
First, it is much easier to run a high volume facility. Take my example of a containerboard plant with 7 tons of product each day. This would be a very difficult plant to manage 40ears ago. I wouldn't want to imagine sourcing the raw materials and then managing the delivery of final products without a modern onsite IT solution (such as SAP). I'm not saying that it wasn't done, but the challenge would impact the cost benefit analysis. Today, these issues are almost fully automated and can be managed by a handful of professionals. Higher volume facilities promote consolidation.
Second, financial systems have been revolutionized. Take two companies that have a very straightforward business--Coca-Cola and Pepsi. You can get a Coke and Pepsi in almost any country on earth. Both have recently altered their business model by directly running many bottling operations. Can you imagine accounting for global businesses like this without a global accounting system that automates key calculations? You could locally account for the operations in each country, but imagine then having to consolidate them--with all accounts converted from foreign to US currency? Getting the numbers right seems almost impossible, but then to analyze the data to be useful for management reporting? Yes there were computers 40 years ago, but I think the changes since then have uniquely in history removed many of the barriers to creating large and complex financial entities.
All of this is relevant because larger, yet still nimble, organizations can give a lot of money to top executives without materially affecting the bottom line. You may be outraged that Coke is paying an executive $50 million a year (I'm making that number up), but if the company is worth $150 billion such a number doesn't matter.
Quote from: DGuller on May 03, 2012, 06:18:42 PM
Do reliable productivity and wage statistics exist for other countries? My first instinct would be to look at the trends in other countries, look for equivalent transformations or lack of them are are hypothesized to cause this decoupling pattern, and see if that relationship holds. Of course, there are multiple dangers with that approach, the main one being that other countries may have their own unique things going on that we might be at best vaguely aware of.
Yeah, I was wondering the same thing.
Quote from: DGuller on May 03, 2012, 06:18:42 PM
Do reliable productivity and wage statistics exist for other countries?
No. Only in America.
For reunified Germany (not quite the same as it uses wage share instead of average income):
(https://languish.org/forums/proxy.php?request=http%3A%2F%2Fwww.jjahnke.net%2Findex_files%2F04896.gif&hash=b4abe42b7a998b8d7d8cbbcf4c51de9f7180b27f)
Blue: Productivity per work hour.
Red: Wage Share (http://en.wikipedia.org/wiki/Wage_share) based on GDP
Green: GDP
2000 = 100
Swedish GDP/hour.
(https://languish.org/forums/proxy.php?request=http%3A%2F%2Fi13.photobucket.com%2Falbums%2Fa299%2FSlayhem%2FProduktivitet.jpg&hash=b20f982ab37d4300f1dcf56aa3164295850ce157)
Part of total production cost that's wages.
(https://languish.org/forums/proxy.php?request=http%3A%2F%2Fi13.photobucket.com%2Falbums%2Fa299%2FSlayhem%2FWorker.jpg&hash=564773164125fef2796283b6bc9efd2dcca48906)
Quote from: The Brain on May 04, 2012, 01:21:04 AM
Part of total production cost that's wages.
(https://languish.org/forums/proxy.php?request=http%3A%2F%2Fi13.photobucket.com%2Falbums%2Fa299%2FSlayhem%2FWorker.jpg&hash=564773164125fef2796283b6bc9efd2dcca48906)
Interesting, considering that German corporations usually keep harping about too high wage costs in Germany.
But then again, corps like to threaten "OMGWTFBBQ IF WE DON'T GET WHAT WE WILL MOVE THE JOBS ELSEWEIR!!!111one"
Quote from: The Brain on May 03, 2012, 03:13:09 PM
:rolleyes: Now you find yourself in '82. What's next?
^_^
:hug:
Quote from: Admiral Yi on May 03, 2012, 06:14:07 PM
As you yourself say, the earliest GATT rounds dealt only with trade liberalization. The one necessary precondition for globalization was liberalization of capital markets. And I may be wrong, but I think that particular round of GATT coincides more or less with the opening of China, and both coincide more or less with the time frame you're focusing on.
Time frame is too late. Capital market liberalization was a later focus of the Uruguay Round during the 90s and China likewise was not a significant factor in international trade and finance until the mid-90s.
Quote from: The Minsky Moment on May 04, 2012, 11:31:31 AM
Time frame is too late. Capital market liberalization was a later focus of the Uruguay Round during the 90s and China likewise was not a significant factor in international trade and finance until the mid-90s.
Then add in the computer revolution, which dramatically altered the cost ratio of labor and capital.
PART IV
To sum up to date: the basic neo-classical model predicts that there shouldn't be long-term divergence between the marginal product of labor and its price (wage). Post war data from the US indicate this roughly holds from about 1947-1981/2, but that after that point divergence occurs and steadily grows over the next 3 deades. That focuses the search on some phenomena that (a) experienced a sharp discontunuity in the late 70s/early 80s, and (b) break the model. IMO this disqualifies common explanations like technology/automation or de-industralization, which have been continuous phenemona throughout the entire post-war period (and which are accounted for theoretically in the neo-classical model), or off-shoring/China which doesn't really take off in a sigificant way until the 90s. That leads me to focus on financialization which does seem to take off in a hockey-stick graph kind of way starting around the late-70s.
At the high level of theory in the neo-classical model, all markets clear and quickly reach equilibrium. However, the model is based on a barter economy - it does not take into account financial assets. JS Mill previewed this shortcoming well in connection with the earlier classical school - he noted that Say's Law, which states that all markets clear and thus gluts and overproduction are not possible - does not hold strictly in a world of financial assets, which breaks the continuity between the purchase and sale of physical commodities. In other words, in a world of financial assets, a seller of a commodity does not have to simultaenously purchase something else (and hence create the conditions of employment that support its production). Rather, he can choose to increase holdings of financial assets and thus delay the positive employment impact.
That brings us to basic monetary theory. The demand for financial assets is often categorized by three basic motives: transactional, precautionary and speculative. The transactional motive is the need to provide a monetary lubricant to commerce and eliminate the inefficiencies and matching problems inherent in pure barter. The transactional motive practically translates in the need to hold a certain amount of financial assets (money) in rough proportion to the amount of real transactions. It is basically a small cost of "doing business" at the economy-wide level and as such does not really disturb the neo-classical model.
The precautionary motive is equivalent to Keynes' notion of liqudiity preference and reflects the motivation to hold financial assets as a store of value to hedge against uncertainty and the risk of economic collapse. The speculative motive - the desire to hold financial assets in order to reap economic profits from doing so - is the flip side of the same coin. The precautionary motive and the speculative motive are both forces that drive people to hold more financial assets than strictly required for transactional purposes; in the case of the precautionary motive, the demand is for safe financial assets, whereas the speculative motive drives demand for risky financial assets. Both motives are not accounted for in the basic neo-classical model, and as JS Mill observed back in the 1840s, they break it by permitting conditions of excess production and stagnation (depression). Keynes' General Theory still remains the classic theory of how the precautionary demand for money in times of uncertainty can result in a recessionary dis-equilibrium; the Austrians and Minsky did the same concerning how the speculatuive motive can cause unsustainable booms that create the seeds of the crash.
That is the basic theory, what remains is to apply it to the facts at hand.
I can't wait to see what happens next :)
PART V: Profit ?
So I admit that I put out a poorly enunciated argument and that I cut it off half way because I needed to leave, but does anyone have a comment on my point of view that the "financial innovation" of the past 30-40 years wasn't due to deregulation but rather new demand?
A part of the argument for this that I didn't add was the collapse of Bretton Woods.
Quote from: Oexmelin on May 04, 2012, 12:19:16 PM
PART V: Profit ?
Yeah, that is what I am thinking. Just looking at the Canadian scene. A lot of our major corporations showed increasing profitability while wages grew slowly - except amongst the executive suite. Just look at our banks - sorry Yanks had to be said. ;)
I dont think this is a story of executives creaming off all the dough though. I think this is a story that started out as a desire to boost shareholder return but all too often ended poorly.
Quote from: crazy canuck on May 04, 2012, 12:40:38 PMYeah, that is what I am thinking. Just looking at the Canadian scene. A lot of our major corporations showed increasing profitability while wages grew slowly - except amongst the executive suite. Just look at our banks - sorry Yanks had to be said. ;)
I dont think this is a story of executives creaming off all the dough though. I think this is a story that started out as a desire to boost shareholder return but all too often ended poorly.
Yeah, that sounds about right. The huge growth in executive pay was the result of competition in the very narrow labour market of people who could boost shareholder returns exponentially.
... that's my uneducated guess.
Quote from: alfred russel on May 04, 2012, 12:26:00 PM
So I admit that I put out a poorly enunciated argument and that I cut it off half way because I needed to leave, but does anyone have a comment on my point of view that the "financial innovation" of the past 30-40 years wasn't due to deregulation but rather new demand?
A part of the argument for this that I didn't add was the collapse of Bretton Woods.
I imagine there wasn't much demand for currency swaps in a fixed exchange rate system.
Actually I think it's much harder to make the argument that financial innovations have occured in the total absence of demand.
Quote from: Admiral Yi on May 04, 2012, 01:34:05 PM
Actually I think it's much harder to make the argument that financial innovations have occured in the total absence of demand.
Is anyone arguing that?
Quote from: Jacob on May 04, 2012, 01:37:18 PM
Is anyone arguing that?
Anyone in the world? I think so. Fairly common trope in the progressive media that the purpose of financial innovation is to swindle people.
Quote from: Admiral Yi on May 04, 2012, 01:39:37 PM
Quote from: Jacob on May 04, 2012, 01:37:18 PM
Is anyone arguing that?
Anyone in the world? I think so. Fairly common trope in the progressive media that the purpose of financial innovation is to swindle people.
:lol:
I meant anyone in the thread.
Quote from: Jacob on May 04, 2012, 01:40:30 PM
:lol:
I meant anyone in the thread.
It was implicit in Fredo's question. And implicit (or at least suggested) in the theory Joan is constructing about deadweight loss financialization.
Quote from: Admiral Yi on May 04, 2012, 01:34:05 PM
Actually I think it's much harder to make the argument that financial innovations have occured in the total absence of demand.
Demand could've always been there, but it could not be supplied until deregulation made it feasible. And, for the record, I personally never claimed that financial innovations are necessarily bad. Efficient risk management that financial innovation allows can certainly allow you to utilize capital more efficiently, which is good for society. The problem is that just because something can be beneficial doesn't mean that it can't also be harmful, and complicated financial instruments can certainly be socially harmful, either due to misaligned incentives, or by the accidents they lead to in the course of doing something socially beneficial.
Quote from: Admiral Yi on May 04, 2012, 01:03:53 PM
Quote from: alfred russel on May 04, 2012, 12:26:00 PM
So I admit that I put out a poorly enunciated argument and that I cut it off half way because I needed to leave, but does anyone have a comment on my point of view that the "financial innovation" of the past 30-40 years wasn't due to deregulation but rather new demand?
A part of the argument for this that I didn't add was the collapse of Bretton Woods.
I imagine there wasn't much demand for currency swaps in a fixed exchange rate system.
That was a part of the point I was making (or at least trying to). :P
Quote from: Jacob on May 04, 2012, 01:37:18 PM
Quote from: Admiral Yi on May 04, 2012, 01:34:05 PM
Actually I think it's much harder to make the argument that financial innovations have occured in the total absence of demand.
Is anyone arguing that?
I am trying to. JR has started with the premise that there has been significant financial innovation in the past 35 years (I think everyone agrees). To explain why he is discussing regulatory changes. I'm trying to bring up the idea that there were more fundamental changes to business that drove the financial innovation (and in turn the regulatory changes he is discussing).
In my view the deregulation of the financial sector is largely what is responsible for the innovation which occured. And, in my view deregulation was largely ideological. The early 80s in America were all about cutting out all the red tape that was holding business back. Then when the financial markets began to "innovate" and take advantage of its new found freedom there was a political judgment made not to regulate the new financial products that were being created.
I recall a discussion around derivatives and the "whiz kids" that created them. To some extent the debate was whether or not to regulate but there was also an aspect of how one would do such thing because very few people really understood what the heck they were or how they worked.
Well, the widespread adoption of polices from the Austrian economic school did immediately precede this change. The similar Laissez-faire ideas that preceded the progressive era also produced similar economic unbalances.
Quote from: Josephus on May 04, 2012, 02:42:17 PM
Quote from: Admiral Yi on May 04, 2012, 01:39:37 PM
Quote from: Jacob on May 04, 2012, 01:37:18 PM
Is anyone arguing that?
Anyone in the world? I think so. Fairly common trope in the progressive media that the purpose of financial innovation is to swindle people.
WEll....the purpose of financial innovation is to make more profits. Which in the end means swindling people. That's the nature of capitalism.
:rolleyes: That is why I will never vote NDP. I think most of you actually believe that.
Josephus just mongered his post!! :o
Quote from: Razgovory on May 04, 2012, 02:31:25 PM
The similar Laissez-faire ideas that preceded the progressive era also produced similar economic unbalances.
They didn't though. That's why the question is what changed in the late 70s/early 80s that had never been the case before. Otherwise, we'd be able to just point to the previous times and see.
I still say the transition time between ending Bretton Woods and the Plaza Accords has something to do with it.
Quote from: crazy canuck on May 04, 2012, 02:43:18 PM
Quote from: Josephus on May 04, 2012, 02:42:17 PM
Quote from: Admiral Yi on May 04, 2012, 01:39:37 PM
Quote from: Jacob on May 04, 2012, 01:37:18 PM
Is anyone arguing that?
Anyone in the world? I think so. Fairly common trope in the progressive media that the purpose of financial innovation is to swindle people.
WEll....the purpose of financial innovation is to make more profits. Which in the end means swindling people. That's the nature of capitalism.
:rolleyes: That is why I will never vote NDP. I think most of you actually believe that.
Well.......I did delete that post...but not fast enough. :D
Quote from: Jacob on May 04, 2012, 12:57:05 PM
Yeah, that sounds about right. The huge growth in executive pay was the result of competition in the very narrow labour market of people who could boost shareholder returns exponentially.
... that's my uneducated guess.
I think a more sociologically based argument could easily be made that you have a semi-closed sub-group which basically rewards itself in what is essentially a non-state bureaucratic organization (i.e., which incorporates the lack of accountability which is a by-product of large-scale organization).
Quote from: Oexmelin on May 04, 2012, 04:01:04 PM
Quote from: Jacob on May 04, 2012, 12:57:05 PM
Yeah, that sounds about right. The huge growth in executive pay was the result of competition in the very narrow labour market of people who could boost shareholder returns exponentially.
... that's my uneducated guess.
I think a more sociologically based argument could easily be made that you have a semi-closed sub-group which basically rewards itself in what is essentially a non-state bureaucratic organization (i.e., which incorporates the lack of accountability which is a by-product of large-scale organization).
Naw, generally there was plenty of accountability. Its just that well intentioned people got sucked into the notion that paying the executive suite incentives would maximize shareholder value. That was a genuinely held belief. It wasnt something cooked up to "swindle" everyone.
It took a number of years before people began to realize that the kinds of incentives that were being given didnt help maximize shareholder value at all. Often the reverse was true. Now compensation committees are struggling with where to go from here.
Also, there was the kind of phenomenon that took place with hockey agents. As the level of executive compensation rose compensation committees were concerned that they didnt want to lose their talented executives and so joined in. fyi a similar kind of madness took hold with junior associate compensation about the same time but I digress.
Quote from: MadImmortalMan on May 04, 2012, 02:49:05 PM
Quote from: Razgovory on May 04, 2012, 02:31:25 PM
The similar Laissez-faire ideas that preceded the progressive era also produced similar economic unbalances.
They didn't though. That's why the question is what changed in the late 70s/early 80s that had never been the case before. Otherwise, we'd be able to just point to the previous times and see.
I still say the transition time between ending Bretton Woods and the Plaza Accords has something to do with it.
They didn't what?
Quote from: Razgovory on May 04, 2012, 05:04:47 PM
Quote from: MadImmortalMan on May 04, 2012, 02:49:05 PM
Quote from: Razgovory on May 04, 2012, 02:31:25 PM
The similar Laissez-faire ideas that preceded the progressive era also produced similar economic unbalances.
They didn't though. That's why the question is what changed in the late 70s/early 80s that had never been the case before. Otherwise, we'd be able to just point to the previous times and see.
I still say the transition time between ending Bretton Woods and the Plaza Accords has something to do with it.
They didn't what?
Produce the similar imbalances.
I dunno, 19th and early 20th century the balance of wealth was fairly stratified.
Yeah, but the disconnect we're discussing is in labor productivity vs worker compensation, not relative wealth between rich and poor.
Quote from: crazy canuck on May 04, 2012, 02:17:31 PM
In my view the deregulation of the financial sector is largely what is responsible for the innovation which occured. And, in my view deregulation was largely ideological. The early 80s in America were all about cutting out all the red tape that was holding business back. Then when the financial markets began to "innovate" and take advantage of its new found freedom there was a political judgment made not to regulate the new financial products that were being created.
I recall a discussion around derivatives and the "whiz kids" that created them. To some extent the debate was whether or not to regulate but there was also an aspect of how one would do such thing because very few people really understood what the heck they were or how they worked.
Outside of options (which have a long history and aren't colloquially referred to as derivatives in any event), by far the two most ubiquitous types of derivatives among American companies are foreign currency swaps and interest rate swaps. There wouldn't have been much demand for the former in the Bretton Woods world. The rise in demand for the latter is more difficult to explain, but certainly they require a threshold of large companies offering debt to both cover the overhead and create enough demand to allow intermediaries to avoid accumulating risk. At the same time, the stable interest rate and inflation world of the 1950s and 1960s broke down with the stagflation of the 70s and early 80s. There was a heightened awareness of interest rate risk.
For academics, swaps aren't exotic and complex. Their use is going to be taught in any risk management class in B school when interest rate risk and currency risk comes up. It isn't as though "whiz kids" on wall street have come up with products few understand and managed to pawn them off on almost every company in America: if companies want them to mitigate the risk associated with a newly volatile currency and interest rate environment, and academics are saying their use makes sense, it doesn't seem likely for the government to get in the way.
Quote from: alfred russel on May 04, 2012, 06:51:20 PM
For academics, swaps aren't exotic and complex. Their use is going to be taught in any risk management class in B school when interest rate risk and currency risk comes up. It isn't as though "whiz kids" on wall street have come up with products few understand and managed to pawn them off on almost every company in America: if companies want them to mitigate the risk associated with a newly volatile currency and interest rate environment, and academics are saying their use makes sense, it doesn't seem likely for the government to get in the way.
I doubt you rather sweeping statement that derivatives are not complex - even for academics today. But for sure they were exotic and complex when they were first introduced. I think you are probably a bit too young to remember that.
Who cares? As long as I get mine...
I can't recall ever reading about "complex, difficult to understand derivatives" before the subprime meltdown.
Quote from: Admiral Yi on May 04, 2012, 08:38:24 PM
I can't recall ever reading about "complex, difficult to understand derivatives" before the subprime meltdown.
I do. :huh: It was mainly in articles predicting the financial meltdown (I refuse to call it a subprime meltdown, because it deliberately marginalizes the true nature of the meltdown).
Part of the problem I'm having with trying to apply economic theory to explain the changes in the last 30 years or so is that all of the proposed explanations would seem to be things that in theory should cause increased unemployment, not wage stagnation for those who still have jobs.
Quote from: crazy canuck on May 04, 2012, 04:42:12 PMIts just that well intentioned people got sucked into the notion that paying the executive suite incentives would maximize shareholder value. That was a genuinely held belief. It wasnt something cooked up to "swindle" everyone.
That has nothing to do with what I wrote, though. I am not talking about nefarious conspiracies of evil-doers. I am talking about some basic group sociology forces. One the one hand, people reward "people like them" all the time. Sometimes it is a somewhat explicit ideology (old boys networks, patronage, shared ethnicity); most of the time, it is an implicit ideology, with lots of unspoken asumptions ("we reward merit"). On the other, bureaucracies are filled with people who genuinely hold beliefs about what they do, that they do it for the best of the society/the shareholders, and few ever think that what they are doing is there to swindle anyone.
What I meant by lack of accountability is at its most basic sense: giving accounts of what you do - and this happens when you are forced to explain things to people from "outside" the system, because sometimes you realize you are also explaining them to yourself. Deregulation removed one incentive from that kind of rendering accounts. The very, *very* closed society of high flying managers with few incentives to explain what they are doing is another. The bureaucratization of both firms, and accounting bureaus is yet another (and, again, by that I don't mean evil bad government, but the increasingly routine, increasingly compartimentalized structure of financial institutions). And perhaps the financiarization of the economy in general with its dissolution of shareholders into faceless forces might be another.
Quote from: crazy canuck on May 04, 2012, 08:06:23 PM
Quote from: alfred russel on May 04, 2012, 06:51:20 PM
For academics, swaps aren't exotic and complex. Their use is going to be taught in any risk management class in B school when interest rate risk and currency risk comes up. It isn't as though "whiz kids" on wall street have come up with products few understand and managed to pawn them off on almost every company in America: if companies want them to mitigate the risk associated with a newly volatile currency and interest rate environment, and academics are saying their use makes sense, it doesn't seem likely for the government to get in the way.
I doubt you rather sweeping statement that derivatives are not complex - even for academics today. But for sure they were exotic and complex when they were first introduced. I think you are probably a bit too young to remember that.
Interest rate swaps and foreign exchange swaps aren't complex--the concepts are probably standard fare in undergraduate coursework for accounting and finance majors, and the agreements basically boilerplate with a dozen or so customizable terms. The risk management for an investment bank acting as an intermediary for a bunch of these is very complex, and how to regulate them a nightmare (neither is really the concern of a corporation, though maybe counterparty risk should matter more). At the outset the legal environment was also less resolved.
I am too young to be working with derivatives in the mid 70s-early 80s, you have me there. :P
Quote from: DGuller on May 04, 2012, 08:42:00 PM
I do. :huh: It was mainly in articles predicting the financial meltdown (I refuse to call it a subprime meltdown, because it deliberately marginalizes the true nature of the meltdown).
It's interesting that people were able to predict the meltdown without knowing how the instruments worked.
Quote from: Oexmelin on May 04, 2012, 10:25:24 PM
That has nothing to do with what I wrote, though. I am not talking about nefarious conspiracies of evil-doers. I am talking about some basic group sociology forces. One the one hand, people reward "people like them" all the time. Sometimes it is a somewhat explicit ideology (old boys networks, patronage, shared ethnicity); most of the time, it is an implicit ideology, with lots of unspoken asumptions ("we reward merit"). On the other, bureaucracies are filled with people who genuinely hold beliefs about what they do, that they do it for the best of the society/the shareholders, and few ever think that what they are doing is there to swindle anyone.
What I meant by lack of accountability is at its most basic sense: giving accounts of what you do - and this happens when you are forced to explain things to people from "outside" the system, because sometimes you realize you are also explaining them to yourself. Deregulation removed one incentive from that kind of rendering accounts. The very, *very* closed society of high flying managers with few incentives to explain what they are doing is another. The bureaucratization of both firms, and accounting bureaus is yet another (and, again, by that I don't mean evil bad government, but the increasingly routine, increasingly compartimentalized structure of financial institutions). And perhaps the financiarization of the economy in general with its dissolution of shareholders into faceless forces might be another.
Even though I disagree with you on a lot of stuff, I think you have a point here, only I would expand it beyond class. There is an adage to "stay close to the executives," whether you are a secretary or a senior manager. The idea is that when there is a pool for bonuses or other rewards they go to the people and groups the executives see on a daily basis, not the faceless people and groups around the world. I've seen it said in the business press that you know a company is serious about cost cutting when they start layoffs within the home office rather than just field locations.
But Oex, I think you should take into account that if you are talking about just the executives, at larger companies $20 million a year just isn't going to show up in the bottom line, but executive performance will.
Quote from: crazy canuck on May 04, 2012, 08:06:23 PM
I doubt you rather sweeping statement that derivatives are not complex - even for academics today. But for sure they were exotic and complex when they were first introduced. I think you are probably a bit too young to remember that.
Maybe only CC would care (and maybe not him), but a brief description of one of the most common derivatives-a currency swap-would help.
CC, lets say you own a Canadian business and I own an American one. You make a significant in the US, and I do in Canada. Both of us are worried--we need the income from our cross border investments to pay debts (or pay dividends, fund operations, meet earnings expectations, etc) in our home countries, but while we are confident the income streams will be sufficient at current exchange rates, we are concerned they won't be if there are significant changes in exchange rates.
[to keep the rates straightforward lets assume that the US Dollar (USD) and Canadian Dollar (CAD) are at parity and expected to stay there for the foreseeable future] You are confident you will get $1m USD from your US operations, and that is how much you need to bring back to Canada. I am confident I will get $1m CAD from my Canadian operations, and that is how much I need to bring back to the US.
So you and I enter a deal. I will give you payments of $1m CAD for each of the next three years and you will give me $1m USD for each of the next three years. In effect, each of us has been protected from the risk of currency fluctuations over the next few years, though we are now exposed to counterparty risk (one of us may not be able to pay the other, and the swap agreement may thus become void).
That is a very idealized version of a currency swap. The real world differs in a few ways. First, neither of us would find each other--we would both go to an investment bank. Second, we wouldn't exchange cash flows with the investment bank--we would likely just have a net cash settlement feature at the end. For example, I would go to the investment bank and tell them I have $1m CAD coming in the next 3 years that I want to lock into USD at current rates (parity, in this example). We would enter a swap agreement, and the only time cash would change hands is at the end of the agreement: basically if the CAD cash flows I described would have been converted to USD at less than $1m, the investment bank will pay me the difference. If they would have been more, I will give the investment bank the extra benefit.
There are different types of derivatives, and some can get complex, but I don't think that led to any problem (credit default swaps aren't conceptual complex either, but seem to have caused some trouble).
Where there is complexity is with counterparty risk. Derivatives are everywhere: I would guess every company in the S&P500 has some. If an investment bank goes down, that means a lot of companies could be owed a lot of money that they were counting on (for the in the money derivatives). But where the real complexity comes in is the risk management of an investment bank. Derivatives are generally customizable agreements, so if I want an agreement to protect my CAD to USD cash flows you aren't going to find a perfect counterparty for that. The investment bank is going to be left with some exposure. I really don't know how they manage that risk. For a regulator coming in to a company that they don't know with literally trillions in the notional value of derivatives outstanding (and perhaps a company staff not inclined to help them understand everything), the challenge is worse.
There is also trouble in that they can allow speculation because of the way they are valued. If I enter a bet on a coin toss, putting $1 in, and winning $2 if I lose, until the coin is flipped you can't recognize a loss (my expected gain is $1 after all, what I put in). However, if I bet all my company assets on the coin toss, an investor could be misled and not understand there is a 50-50 chance the company won't be around tomorrow. If we disclosed that we had bet all our money on a coin toss, this likely wouldn't be a problem, everyone would understand what was going on. But if we ran the speculation through derivative agreements, of which we already had thousands, probably no one would notice. AIG, for example, was a massive insurance company that decided to make massive bets that the housing market wouldn't collapse. I went back and read their financial filings--they actually highlighted the risk that they were very exposed to the housing market. Their auditor took the very unusual step of indicating a risk regarding financial controls in this area. But I think most investors were shocked to find out that the insurance company they thought they were investing in had become a wild real estate speculator.
Quote from: Admiral Yi on May 04, 2012, 08:38:24 PM
I can't recall ever reading about "complex, difficult to understand derivatives" before the subprime meltdown.
Then you were not reading carefully enough.
Also, I am not just talking about the periold before the meltdown. I am also talking about the period when these things were first introduced which coincided or at least closely followed deregulation in the early 80s.
Quote from: alfred russel on May 05, 2012, 09:59:24 AM
There are different types of derivatives, and some can get complex, but I don't think that led to any problem (credit default swaps aren't conceptual complex either, but seem to have caused some trouble).
You are ingoring the problem Alfred. You might be able to create a derivative that is easy to understand. But that doesnt address the issue that actual derivatives are complex instruments that few actually understand. From just one of many articles on the subject.
http://www.ft.com/cms/s/0/833a0994-6e32-11df-ab79-00144feabdc0.html#ixzz1u0hPZpnf
QuoteFor banks, the Dr.Jekyll of derivative trading is the revenues generated. The Dr. Hyde is the risks in derivative trading, generally deferred into a Panglossian future "neverland" using complex models, based on arcane mathematics and confidence that only willful ignorance can support.
The complexity of modern derivatives has little to do with risk transfer and everything to do with profits. As new products are immediately copied by competitors, traders must "innovate" to maintain revenue by increasing volumes or creating new structures. Complexity delays competition, prevents clients from unbundling products and generally reduces transparency. Frequently, the models used to price, hedge and determine the profitability also manage to confuse managers and controllers within banks themselves allowing traders to book large fictitious "profits" that their bonuses are based on. In Warren Buffet's words this allows the dealer to see "... where the arrow of performance lands and then [paint] the bull's eye around it".
Quote from: Admiral Yi on May 05, 2012, 04:09:46 AM
Quote from: DGuller on May 04, 2012, 08:42:00 PM
I do. :huh: It was mainly in articles predicting the financial meltdown (I refuse to call it a subprime meltdown, because it deliberately marginalizes the true nature of the meltdown).
It's interesting that people were able to predict the meltdown without knowing how the instruments worked.
You didn't have to really know exactly how they worked. All you had to know is that none of the people knew how they worked, that they had a lot of hidden leverage, and that their volume was enormous.
Quote from: Oexmelin on May 04, 2012, 10:25:24 PM
What I meant by lack of accountability is at its most basic sense: giving accounts of what you do - and this happens when you are forced to explain things to people from "outside" the system, because sometimes you realize you are also explaining them to yourself. Deregulation removed one incentive from that kind of rendering accounts. The very, *very* closed society of high flying managers with few incentives to explain what they are doing is another. The bureaucratization of both firms, and accounting bureaus is yet another (and, again, by that I don't mean evil bad government, but the increasingly routine, increasingly compartimentalized structure of financial institutions). And perhaps the financiarization of the economy in general with its dissolution of shareholders into faceless forces might be another.
Even if Oex was sitting in a board room in the 90s and his task in a compensation committee was to determine the appropriate compensation for an executive I daresay even Oex would look at what the competition was doing. Also, even Oex would feel the pressure of the shareholders to make sure the best executive talent was retained. I dont think even Oex would have been the lone voice in the wilderness saying the world was flat. Remember this was a time when secretaries on the bus were talking about what stocks to trade. And Oex is no high flyer.
It is easy in hindsight to point and think about how stupid it all was. But that is just hindsight. Its like Alfred trying to claim after the fact that derivatives really are not that complex - even though the complexity of the instruments fooled most people.
And, by how they worked, I mean the distribution of outcomes, and their probabilities, as well as what impact counterparty risk would have on other business. Some common derivatives may not have been all that complex by themselves, but that's just part of the picture. Another part of the pictures is knowing what happens even with simple derivatives during the tail events, and any derivative can add to the contagion.
Quote from: DGuller on May 05, 2012, 10:46:22 AM
Quote from: Admiral Yi on May 05, 2012, 04:09:46 AM
Quote from: DGuller on May 04, 2012, 08:42:00 PM
I do. :huh: It was mainly in articles predicting the financial meltdown (I refuse to call it a subprime meltdown, because it deliberately marginalizes the true nature of the meltdown).
It's interesting that people were able to predict the meltdown without knowing how the instruments worked.
You didn't have to really know exactly how they worked. All you had to know is that none of the people knew how they worked, that they had a lot of hidden leverage, and that their volume was enormous.
Exactly, that is why there was a push to try to regulate them. Something Greenspan firmly opposed. He won. We lost.
Quote from: crazy canuck on May 05, 2012, 10:44:26 AM
You are ingoring the problem Alfred. You might be able to create a derivative that is easy to understand. But that doesnt address the issue that actual derivatives are complex instruments that few actually understand. From just one of many articles on the subject.
http://www.ft.com/cms/s/0/833a0994-6e32-11df-ab79-00144feabdc0.html#ixzz1u0hPZpnf
:huh: That is a standard and very common type of derivative. I've worked with derivatives at a number of companies and with the exception that multiple derivaties (including options) are sometimes in a single contract, that is usually as complex as they get.
Quote from: DGuller on May 05, 2012, 10:53:14 AM
And, by how they worked, I mean the distribution of outcomes, and their probabilities, as well as what impact counterparty risk would have on other business. Some common derivatives may not have been all that complex by themselves, but that's just part of the picture. Another part of the pictures is knowing what happens even with simple derivatives during the tail events, and any derivative can add to the contagion.
As I posted yesterday:
"Where there is complexity is with counterparty risk."
But here is an unattractive question that I have heard come up, including before the crash: "Who cares?" If your counterparty is a large institutional, it isn't going to fail unless the market collapses in an unprecedented fashion, and is such an event worth planning for?
Quote from: alfred russel on May 05, 2012, 12:05:12 PM
Quote from: crazy canuck on May 05, 2012, 10:44:26 AM
You are ingoring the problem Alfred. You might be able to create a derivative that is easy to understand. But that doesnt address the issue that actual derivatives are complex instruments that few actually understand. From just one of many articles on the subject.
http://www.ft.com/cms/s/0/833a0994-6e32-11df-ab79-00144feabdc0.html#ixzz1u0hPZpnf
:huh: That is a standard and very common type of derivative. I've worked with derivatives at a number of companies and with the exception that multiple derivaties (including options) are sometimes in a single contract, that is usually as complex as they get.
Ok Alfred, you are the smartest guy in the room.
http://en.wikipedia.org/wiki/Enron:_The_Smartest_Guys_in_the_Room
:P
But you are seriously missing the point. It is not that derivatives could be created in a simple straight forward manner so that they are transparent and everyone on both sides of the deal fully understands the risk. It is that they are not created that way more often than not.
Quote from: alfred russel on May 05, 2012, 12:10:27 PM
But here is an unattractive question that I have heard come up, including before the crash: "Who cares?" If your counterparty is a large institutional, it isn't going to fail unless the market collapses in an unprecedented fashion, and is such an event worth planning for?
If people dont understand what they are bargaining for then there is no problem?
Quote from: alfred russel on May 05, 2012, 12:10:27 PM
As I posted yesterday:
"Where there is complexity is with counterparty risk."
But here is an unattractive question that I have heard come up, including before the crash: "Who cares?" If your counterparty is a large institutional, it isn't going to fail unless the market collapses in an unprecedented fashion, and is such an event worth planning for?
The problem in finance is that if you discount the possibility of a nuclear event, because you can't really protect yourself against it anyway, your consequent actions are skewing the probabilities in such a way that makes the nuclear event more likely.
:)
Quote from: crazy canuck on May 05, 2012, 10:52:45 AM
Even if Oex was sitting in a board room in the 90s...
Why are you writing in such belittling way?
I am not saying the way people acted is stupid, or horrible. I don't know why you insist into attributing aggressive value-judgement on my part on what I aim to describe.
I am trying to complicate the picture by saying economic is also social behaviour, and that therefore, it might make sense to think on how people get their information, are being positively reinforced by a group of identifiable peers, and modify their behaviour according to some organizational principles that are not market-driven.
In other words, I will assume for the sake of argument everything you wrote is true. My point was simply that:
QuoteAlso, even Oex would feel the pressure of the shareholders to make sure the best executive talent was retained.
might warrant an examination of at least four things (I can think of more).
How is the shareholder pressure expressed and conveyed?
Who represents the "desire" of the shareholders? Who interprets them for any sort of compensation committee / board ?
How is "best executive talent" evaluated?
And who gets to judge this?
Now, you might answer to these questions that the market takes care of it all, but that is in the end saying very little about decision-making process.
You might answer - perhaps like JR - that we should bracket these issues away for intelligibility's sake, while we review what current economic thought has to say about it. Fair enough.
But maybe, we can briefly do the reverse as a thought experiment, and bracket the market away and try to understand what kinds of social (rather than strictly methodologically individualistic) forces make people take the decisions they took.
Quote from: crazy canuck on May 05, 2012, 12:41:42 PM
Ok Alfred, you are the smartest guy in the room.
http://en.wikipedia.org/wiki/Enron:_The_Smartest_Guys_in_the_Room
:P
But you are seriously missing the point. It is not that derivatives could be created in a simple straight forward manner so that they are transparent and everyone on both sides of the deal fully understands the risk. It is that they are not created that way more often than not.
I'm not the smartest guy in the room, which is a part of the point here. Almost anyone who has been in a professional finance or accounting role at companies large enough to be publicly traded will have the experience because derivatives are very common. Your larger multinationals probably have thousands of contracts outstanding.
These are contractual relationships between large organizations where both sides should have professionals that know what they are doing.
Quote from: DGuller on May 05, 2012, 12:52:14 PM
The problem in finance is that if you discount the possibility of a nuclear event, because you can't really protect yourself against it anyway, your consequent actions are skewing the probabilities in such a way that makes the nuclear event more likely.
Sounds like a macroeconomic problem. I don't see why an individual company would care (at least when contemplating its own actions).
CC--I don't know what you are trying to say.
Derivatives used by large companies are either to hedge risk or (less often) to speculate: either way they aren't naive consumers. These are strategies they seek to employ.
Derivatives are also used in speculation, often by hedge funds. I again doubt that they don't understand the risks (and have limited sympathy if they don't). Derivatives are a convenient way to replicate the effects of significant leverage.
Maybe you have some concerns that mortgage backed securities were packaged in securities with derivatives embedded. In some cases these received solid ratings and were sold to institutionals who apparently were satisfied with the ratings. The issue here seems to be a problem with a lack of transparency in the securitization process combined with a lack of investigation on the part of consumers. I don't see a reason to think derivatives were the key to misleading the purchasers of the products.
Quote from: crazy canuck on May 05, 2012, 10:37:41 AM
Then you were not reading carefully enough.
Also, I am not just talking about the periold before the meltdown. I am also talking about the period when these things were first introduced which coincided or at least closely followed deregulation in the early 80s.
That's a possiblity. Can you refresh my memory on some of the complex, difficult to understand derivatives that were created in this time frame?
Quote from: Oexmelin on May 05, 2012, 01:05:32 PM
Quote from: crazy canuck on May 05, 2012, 10:52:45 AM
Even if Oex was sitting in a board room in the 90s...
Why are you writing in such belittling way?
Because first you say that there was no accountability, then you qualify accountability to mean that nobody in the room could help themselves because they were all self reinforcing high flyers in a closed club.
Its nonsense.
These kinds of socialogical explanations ignore the fact that there were some very smart well meaning people that simply got it wrong - not because they were members of some "high flying" elite club. But because that is what everyone thought was the best practice back in the day.
Quote from: Admiral Yi on May 05, 2012, 02:05:03 PM
Quote from: crazy canuck on May 05, 2012, 10:37:41 AM
Then you were not reading carefully enough.
Also, I am not just talking about the periold before the meltdown. I am also talking about the period when these things were first introduced which coincided or at least closely followed deregulation in the early 80s.
That's a possiblity. Can you refresh my memory on some of the complex, difficult to understand derivatives that were created in this time frame?
No, you can go through the multitude of articles on the subject.
Quote from: alfred russel on May 05, 2012, 01:21:01 PM
Derivatives used by large companies are either to hedge risk or (less often) to speculate: either way they aren't naive consumers. These are strategies they seek to employ.
One can be more sophisticated then merely naive and still get fooled by a financial product you think you understand but really dont. If the subprime market taught us anything it is at least that.
The fact that a financial instrument was mispriced is not proof of its confusing complexity. There's nothing at all confusing or complex about the various instruments used to own gold.
Quote from: Admiral Yi on May 05, 2012, 02:50:50 PM
The fact that a financial instrument was mispriced is not proof of its confusing complexity.
the Economist disagrees.
QuoteComplexity is a further worry. Richard Bookstaber, who headed market-risk management at Morgan Stanley, says that "complexity cloaks catastrophe". Clients—even supposedly sophisticated ones—do not always understand the risks they are taking on. That's their lookout, you might say, so long as traders do not defraud them and so long as bankrupted clients do not have to be bailed out by the state.
But regulators do have an interest in complexity. It makes valuation difficult: dealers often allocate different values to the same contract. This in turn makes financial accounts more opaque. (Remember Enron.) And the popularity of arcane derivatives has been sustained by "less than lofty purposes", says Mr Bookstaber. For example, under the Basel capital-adequacy rules, when a bank makes a loan to an ordinary company it has to set aside 8% of the loan's value as capital. But for loans to other banks the charge is only 1.6%, because the rules assume banks are more creditworthy. The less they must put aside, the more banks can lend and the more money they can make. This is where CDSs come in handy. A bank overexposed to airlines can use CDSs to share credit risk with other banks and slash the cost of holding the loan. Buying a CDS from AIG, which had a high credit rating, gave banks a similar deal. No wonder they were so eager.
for the full article
http://www.economist.com/node/14843667
Quote from: Admiral Yi on May 05, 2012, 02:50:50 PM
The fact that a financial instrument was mispriced is not proof of its confusing complexity. There's nothing at all confusing or complex about the various instruments used to own gold.
So all those financial institutions understood these products were seriously flawed and invested all their clients money in them anyway? I guess it was a swindle then. And it was a suicide swindle as they intentionally took themselves down at the same time.
Quote from: crazy canuck on May 05, 2012, 02:57:08 PM
Quote from: Admiral Yi on May 05, 2012, 02:50:50 PM
The fact that a financial instrument was mispriced is not proof of its confusing complexity.
the Economist disagrees.
I doubt it. And they certainly don't mention it in the article you linked.
Quote from: Admiral Yi on May 05, 2012, 03:10:57 PM
Quote from: crazy canuck on May 05, 2012, 02:57:08 PM
Quote from: Admiral Yi on May 05, 2012, 02:50:50 PM
The fact that a financial instrument was mispriced is not proof of its confusing complexity.
the Economist disagrees.
I doubt it. And they certainly don't mention it in the article you linked.
I cant wait to hear the Yi interpretation of this then
"[complexity] makes valuation difficult: dealers often allocate different values to the same contract. This in turn makes financial accounts more opaque. (Remember Enron.)"
Quote from: Valmy on May 05, 2012, 02:58:30 PM
So all those financial institutions understood these products were seriously flawed and invested all their clients money in them anyway? I guess it was a swindle then. And it was a suicide swindle as they intentionally took themselves down at the same time.
They understood how they worked. That's not the same as knowing if they're priced correctly. There is no veil of mystery surrounding sovereign bonds, but many turned out to be crap. Stocks are even less of a mystery but people went all in durinig the dot.com bubble anyway.
Quote from: crazy canuck on May 05, 2012, 02:39:27 PM
Because first you say that their was no accountability, then you qualify accountability to mean that nobody in the room could help themselves because they were all self reinforcing high flyers in a closed club.
If you are taking it this way, I won't bother engaging this issue, and probably others, with you. Too bad. And if you'd rather have it in a belittling way, I'd suggest you reread what I have written, for you obviously have not understood a single word, so eager were you to pour the image of the vociferous misguided leftist into whatever I wrote. (hint 1: some words, like accountability, have shifting meanings - it is therefore good practice to define them in order to foster intelligibility; hint 2: you can find research on the effect of social networks on compensation, firing for unethical behaviour, CEO accountability in such leftist venues as the Journal of Financial Economics, to name but one).
Quote from: crazy canuck on May 05, 2012, 03:15:14 PM
I cant wait to hear the Yi interpretation of this then
"[complexity] makes valuation difficult: dealers often allocate different values to the same contract. This in turn makes financial accounts more opaque. (Remember Enron.)"
I'm really baffled that you somehow think an Economist claim about the existence of complexity refutes my statement that misvaluation is not proof complexity.
Quote from: Admiral Yi on May 05, 2012, 03:17:47 PM
They understood how they worked. That's not the same as knowing if they're priced correctly. There is no veil of mystery surrounding sovereign bonds, but many turned out to be crap. Stocks are even less of a mystery but people went all in durinig the dot.com bubble anyway.
I will take what Richard Bookstaber says about complexity masking risk over your assertion that "they" understood.
Quote from: crazy canuck on May 05, 2012, 03:24:52 PM
I will take what Richard Bookstaber says about complexity masking risk over your assertion that "they" understood.
I'll just have to add that to my long list of disappointments in life.
Quote from: Admiral Yi on May 05, 2012, 03:17:47 PM
They understood how they worked. That's not the same as knowing if they're priced correctly. There is no veil of mystery surrounding sovereign bonds, but many turned out to be crap. Stocks are even less of a mystery but people went all in durinig the dot.com bubble anyway.
A financial group understands where are risks involved with stocks and sovereign bonds and you can lose money. But it is a well understood risk with centuries of history behind it and that is why you diversify your portfolio when fund managing. The situation regarding the derivatives suggests for some reason they did not understand the risks they were taking on at all.
Are you actually telling me that only complex financial products lose money? Because LOL
Quote from: Valmy on May 05, 2012, 03:30:39 PM
A financial group understands where are risks involved with stocks and sovereign bonds and you can lose money. But it is a well understood risk with centuries of history behind it and that is why you diversify your portfolio when fund managing. The situation regarding the derivatives suggests for some reason they did not understand the risks they were taking on at all.
Are you actually telling me that only complex financial products lose money? Because LOL
WFT?? No, I'm arguing the exact opposite.
Obviously it is too complicated to even have a comprehensible argument about it.
Quote from: alfred russel on May 05, 2012, 01:13:02 PM
Quote from: DGuller on May 05, 2012, 12:52:14 PM
The problem in finance is that if you discount the possibility of a nuclear event, because you can't really protect yourself against it anyway, your consequent actions are skewing the probabilities in such a way that makes the nuclear event more likely.
Sounds like a macroeconomic problem. I don't see why an individual company would care (at least when contemplating its own actions).
Of course not, hence the need for regulation.
Quote from: alfred russel on May 05, 2012, 01:21:01 PM
CC--I don't know what you are trying to say.
He's trying to say that his reading about derivatives trumps your actual experience in them.
QuoteMaybe you have some concerns that mortgage backed securities were packaged in securities with derivatives embedded. In some cases these received solid ratings and were sold to institutionals who apparently were satisfied with the ratings. The issue here seems to be a problem with a lack of transparency in the securitization process combined with a lack of investigation on the part of consumers. I don't see a reason to think derivatives were the key to misleading the purchasers of the products.
The rating agencies had some serious accountability issues, for sure. The lack of widespread understanding of the nature of the "bet" being made was also, as you note, a factor.
Quote from: DGuller on May 05, 2012, 07:34:48 PM
Of course not, hence the need for regulation.
Good point.
Part V
Fiancialization doesn't create the speculative motive; the motive is always there. It does make it easier and cheaper and provide more avenues and greater potential depth. As actors hold financial assets for speculative purposes, potential investment funds can be diverted from the real economy. Going back to our old example of the Farmer-Captalist and his wondrous machine, imagine instead of using his new profits to buy a new car, he plays the market in commodity options. The link between sellers and buyers of real goods and services is broken and Say's Law falls by the wayside.
There are several caveats to this story though. One is that the new financial infrastructure itself generates some level of additional employment, as people as needed to run IT systems and print up CDO prospectuses (although this is offset by trends to electonic trading). Another is that financialization does provide some spin-off benefit to the real economy in terms of flexibility of financing, although the degree of benefit is relatively small is comparison to the vast increase in overall financial activity.
In the US, since 1982, speculative financial activity drove three boom periods. In each period, those directly involved in speculative activity made extraordinary, unprecedented gains. It also brought benefits to a wider group of people in the form of increases in the value of commonly held assets like stocks, bonds, and most particularly, housing. Wealth effects from the increases allowed for increased consumptions levels, thus offsetting the drain of funds in speculative activity - although as it came principally in the form of higher individual consumption down, some of that impact was lost in overseas via curret account deficits. The net impact in the boom periods on the non-financial sector was ambiguous. If one asks qui bono? the answer is financial speculators, the much broader group of people who provide services to them and their counterparties, and asset holders who were lucky on timing. The other are institutional players in the financial world who may not speculate in the conventional sense, but took advantage of opportnities to exploit leverage.
That brings us to the key feature of this time period - the assymetry of gains in the boom and losses in the bust. The successful financial players in the 20s became the aprochryphal suicides of the 30s. We learned the lessons of the Depression and after WW2 the government has been there to backstop the system. But the original corollary to that protection was a system of regulation premised on a view of financial activity as a regulated utility. Starting in the 80s, the government backsto stayed and indeeed grew beyond all anticipation but the cost of protection was removed from the direct users and beneficiaries and socialized. What results is a massive subsidy paid to speculator, bankers and other institutional users of financial leverage, and paid by everyone else. The subsidy is hidden from view in off-budget commitments, and abstruse Federal Reserve and Treasury operations but it is real and significant.
So as applied to facts of US experience since 1982, financialization has facilitated great returns to speculative holding of financial assets, diverted resources from th rest of the economy to limit losses to such activity, and possibly suppressing investment activity into other economic sectors. At the same time, the government's spending on real good and services has actually declined, in favor of increased transfer payments primarily involving transferring resources from working people to retirees. During the same period, the tax burden on wage earners has not lightened, but it has improved nicely for those with sufficient flexiblity to be able to recharacterize their income as dividends of capital gains.
When talking about the three waves of speculation you're referring to commercial property (and the S&Ls), dot.coms, and the recent real estate bubble?
QuoteThat brings us to the key feature of this time period - the assymetry of gains in the boom and losses in the bust. The successful financial players in the 20s became the aprochryphal suicides of the 30s. We learned the lessons of the Depression and after WW2 the government has been there to backstop the system. But the original corollary to that protection was a system of regulation premised on a view of financial activity as a regulated utility. Starting in the 80s, the government backsto stayed and indeeed grew beyond all anticipation but the cost of protection was removed from the direct users and beneficiaries and socialized. What results is a massive subsidy paid to speculator, bankers and other institutional users of financial leverage, and paid by everyone else. The subsidy is hidden from view in off-budget commitments, and abstruse Federal Reserve and Treasury operations but it is real and significant.
That's what I wanted to drop in the discussion here but felt a bit ouf of place. "deregulation" of the 80s, as mentioned here and elsewhere may have been damaging, but it was because while it removed limits on speculative profits, the protection against grand scale speculative losses certainly remained in place. 2008 being the best example.
Very interesting thread by the way.